Part II: Discussion questions

1. What is a conceptual framework?

A conceptual framework is a coherent system of interrelated objectives and fundamentals
that can lead to consistent standards and that prescribes the nature, function, and limits of
financial accounting and financial statements.
Why is a conceptual framework necessary in financial accounting?
A conceptual framework is necessary in financial accounting for the following reasons:

(1) It enables the FASB to issue more useful and consistent standards in the future.

(2) New issues will be more quickly solvable by reference to an existing framework of
basic theory.

(3) It increases financial statement users' understanding of and confidence in financial

reporting.

(4) It enhances comparability among companies' financial statements.

2. What is the primary objective of financial reporting?

1. Identifying the boundaries of financial reporting

2. Selecting the transactions, other events, and circumstances to be represented
3. How they should be recognized and measured
4. How they should be summarized and reported

Does management stewardship have a role in the objective of financial reporting?

Explain.

3. What is meant by the term “qualitative characteristics of accounting information”?

"Qualitative characteristics of accounting information" are those characteristics which

contribute to the quality or value of the information. The overriding qualitative
characteristic of accounting information is usefulness for decision-making.

4. Briefly describe the two fundamental qualities of useful accounting information.

Relevance and faithful representation are the two primary qualities of useful accounting
information. For information to be relevant, it should be capable of making a difference
in a decision by helping users to form predictions about the outcomes of past, present,
and future events or to confirm or correct expectations. Faithful representation of a
 measure rests on whether the numbers and descriptions match what really existed or
happened.

5. How are materiality’s (and immateriality) related to the proper presentation of

financial statements? What factors and measures should be considered in assessing
the materiality of a misstatement in the presentation of a financial statement?

The concept of materiality refers to the relative significance of an amount, activity, or

item to informative disclosure, proper presentation of financial position, and the results of
operations. Materiality has qualitative and quantitative aspects; both the nature of the
item and its relative size enter into its evaluation.
An accounting misstatement is said to be material if knowledge of the misstatement will
affect the decisions of the average informed reader of the financial statements. Financial
statements are misleading if they omit a material fact or include so many immaterial
matters as to be confusing. In the examination, the auditor concentrates efforts in
proportion to degrees of materiality and relative risk and disregards immaterial items.

The relevant criteria for assessing materiality will depend upon the circumstances and the
nature of the item and will vary greatly among companies. For example, an error in
current assets or current liabilities will be more important for a company with a flow of
funds problem than for one with adequate working capital.

The effect upon net income (or earnings per share) is the most commonly used measure
of materiality. This reflects the prime importance attached to net income by investors and
other users of the statements. The effects upon assets and equities are also important as
are misstatements of individual accounts and subtotals included in the financial
statements. The FASB is proposing a definition of materiality in the Conceptual
Framework, which will be aligned with that in the securities laws and which can used in
disclosure decisions.

There are no rigid standards or guidelines for assessing materiality. The lower bound of
materiality has been variously estimated at 5% of net income, but the determination will
vary based upon the individual case and might not fall within these limits. Certain items,
such as a questionable loan to a company officer, may be considered material even when
minor amounts are involved. In contrast a large misclassification among expense
accounts may not be deemed material if there is no misstatement of net income.
 6. What are the enhancing qualities of the qualitative characteristics?

Enhancing qualities are qualitative characteristics that are complementary to the

fundamental qualitative characteristics. These characteristics distinguish more-useful
information from less-useful information.

Enhancing characteristics are

 comparability,
 verifiability,
 timeliness,
 Understandability.

What is the role of enhancing qualities in the Conceptual Framework?

In providing information to users of financial statements, the Board relies on general-

purpose financial statements. The intent of such statements is to provide the most useful
information possible at minimal cost to various user groups.

7. What are the five basic assumptions that underlie the financial accounting
structure? Describe the major constraint inherent in the presentation of accounting
information.
8. What are some of the costs of providing accounting information? What are some of
the benefits of accounting information? Describe the cost-benefit factors that should
be considered when new accounting standards are being proposed.

9. What are some of the most important specific differences between IFRS and U.S.
GAAP?

1. Local vs. Global

IFRS is used in more than 110 countries around the world, including the EU and many Asian and
South American countries. GAAP, on the other hand, is only used in the United States.
Companies that operate in the U.S. and overseas may have more complexities in their
accounting.

2. Rules vs. Principles

GAAP tends to be more rules-based, while IFRS tends to be more principles-based. Under
GAAP, companies may have industry-specific rules and guidelines to follow, while IFRS has
principles that require judgment and interpretation to determine how they are to be applied in a
given situation.

3. Inventory Methods

Both GAAP and IFRS allow First In, First out (FIFO), weighted-average cost, and specific
identification methods for valuing inventories. However, GAAP also allows the Last In, First out
(LIFO) method, which is not allowed under IFRS. Using the LIFO method may result in
artificially low net income and may not reflect the actual flow of inventory items through a
company.

4. Inventory Write-Down Reversals

Both methods allow inventories to be written down to market value. However, if the market
value later increases, only IFRS allows the earlier write-down to be reversed. Under GAAP,
reversal of earlier write-downs is prohibited. Inventory valuation may be more volatile under
IFRS.

5. Fair Value Revaluations

IFRS allows revaluation of the following assets to fair value if fair value can be measured
reliably: inventories, property, plant & equipment, intangible assets, and investments in
marketable securities. This revaluation may be either an increase or a decrease to the asset’s
value. Under GAAP, revaluation is prohibited except for marketable securities.

6. Impairment Losses

Both standards allow for the recognition of impairment losses on long-lived assets when the
market value of an asset declines. When conditions change, IFRS allows impairment losses to be
reversed for all types of assets except goodwill. GAAP takes a more conservative approach and
prohibits reversals of impairment losses for all types of assets.

7. Intangible Assets

Internal costs to create intangible assets, such as development costs, are capitalized under IFRS
when certain criteria are met. These criteria include consideration of the future economic
benefits.

Under GAAP, development costs are expensed as incurred, with the exception of internally
developed software. For software that will be used externally, costs are capitalized once
technological feasibility has been demonstrated. If the software will only be used internally,
GAAP requires capitalization only during the development stage. IFRS has no specific guidance
for software.

8. Fixed Assets
GAAP requires that long-lived assets, such as buildings, furniture and equipment, be valued at
historic cost and depreciated appropriately. Under IFRS, these same assets are initially valued at
cost, but can later be revalued up or down to market value. Any separate components of an asset
with different useful lives are required to be depreciated separately under IFRS. GAAP allows
for component depreciation, but it is not required.

9. Investment Property

IFRS includes the distinct category of investment property, which is defined as property held for
rental income or capital appreciation. Investment property is initially measured at cost, and can
be subsequently revalued to market value. GAAP has no such separate category.

10. Lease Accounting

While the approaches under GAAP and IFRS share a common framework, there are a few
notable differences. IFRS has an exception, which allows lessees to exclude leases for low-
valued assets, while GAAP has no such exception. The IFRS standard includes leases for some
kinds of intangible assets, while GAAP categorically excludes leases of all intangible assets from
the scope of the lease accounting standard.

10. What are the advantages and disadvantages of converting to IFRS?

List of the Advantages of Adopting IFRS

1. It would create a single set of accounting standards around the world.

2. It would reduce the time, effort, and expense of preparing multiple reports.
3. It would make it easier to monitor and control subsidiaries from foreign countries.
4. It would offer more flexibility in the accounting practices.
5. It would make it easier for all companies to do business in foreign countries.
6. It would help to streamline the system by creating one centralized authoritative
body.
7. It would create a higher return on equity.
8. It would improve the rates of foreign direct investment around the world.
9. It would be helpful to newer investors and smaller investments.

List of the Disadvantages of Adopting IFRS

1. It would increase the cost of implementation for small businesses.

2. It would lead to concerns with standards manipulation
3. It would require global consistency in auditing and enforcement.
4. It would increase the amount of work placed on accountants.
5. It would create an adjustment period filled with tumult.
6. It would require changes at the educational level as well.
 7. It would not reduce the home-court advantage for the modern firm.
8. It would still require global acceptance to be useful.

11. Describe the Key differences between the IFRS and GAAP by giving emphasis with
respect to the following items:
 Financial statements (balance sheet, Profit/loss statement, cash flow statement)
 Inventory
 Fixed assets
 Intangible assets
 Impairment of assets
 Leases

1. Local vs. Global

IFRS is used in more than 110 countries around the world, including the EU and many Asian and
South American countries. GAAP, on the other hand, is only used in the United States.
Companies that operate in the U.S. and overseas may have more complexities in their
accounting.

2. Rules vs. Principles

GAAP tends to be more rules-based, while IFRS tends to be more principles-based. Under
GAAP, companies may have industry-specific rules and guidelines to follow, while IFRS has
principles that require judgment and interpretation to determine how they are to be applied in a
given situation.

3. Inventory Methods

Both GAAP and IFRS allow First In, First out (FIFO), weighted-average cost, and specific
identification methods for valuing inventories. However, GAAP also allows the Last In, First out
(LIFO) method, which is not allowed under IFRS. Using the LIFO method may result in
artificially low net income and may not reflect the actual flow of inventory items through a
company.

4. Inventory Write-Down Reversals

Both methods allow inventories to be written down to market value. However, if the market
value later increases, only IFRS allows the earlier write-down to be reversed. Under GAAP,
reversal of earlier write-downs is prohibited. Inventory valuation may be more volatile under
IFRS.

5. Fair Value Revaluations

IFRS allows revaluation of the following assets to fair value if fair value can be measured
reliably: inventories, property, plant & equipment, intangible assets, and investments in
marketable securities. This revaluation may be either an increase or a decrease to the asset’s
value. Under GAAP, revaluation is prohibited except for marketable securities.

6. Impairment Losses

Both standards allow for the recognition of impairment losses on long-lived assets when the
market value of an asset declines. When conditions change, IFRS allows impairment losses to be
reversed for all types of assets except goodwill. GAAP takes a more conservative approach and
prohibits reversals of impairment losses for all types of assets.

7. Intangible Assets

Internal costs to create intangible assets, such as development costs, are capitalized under IFRS
when certain criteria are met. These criteria include consideration of the future economic
benefits.

Under GAAP, development costs are expensed as incurred, with the exception of internally
developed software. For software that will be used externally, costs are capitalized once
technological feasibility has been demonstrated. If the software will only be used internally,
GAAP requires capitalization only during the development stage. IFRS has no specific guidance
for software.

8. Fixed Assets

GAAP requires that long-lived assets, such as buildings, furniture and equipment, be valued at
historic cost and depreciated appropriately. Under IFRS, these same assets are initially valued at
cost, but can later be revalued up or down to market value. Any separate components of an asset
with different useful lives are required to be depreciated separately under IFRS. GAAP allows
for component depreciation, but it is not required.

9. Investment Property

IFRS includes the distinct category of investment property, which is defined as property held for
rental income or capital appreciation. Investment property is initially measured at cost, and can
be subsequently revalued to market value. GAAP has no such separate category.

10. Lease Accounting

While the approaches under GAAP and IFRS share a common framework, there are a few
notable differences. IFRS has an exception, which allows lessees to exclude leases for low-
valued assets, while GAAP has no such exception. The IFRS standard includes leases for some
kinds of intangible assets, while GAAP categorically excludes leases of all intangible assets from
the scope of the lease accounting standard.

3. Answer the following short answer questions (3 points each)

i) What is meant by IFRS, IAS & IASB? NB: I don’t expect from you just give
meaning for the abbreviation of each rather, I need to briefly explain what each
term would mean and their inter-relationships if any.
ii) How the Full IFRS differs from the IFRS for SMES? What are the criteria’s to be
fulfilled in order to apply the IFRS for SMEs rather than the Full IFRS?
iii) What are the advantages (benefits) and disadvantages (challenges) of adopting
IFRS for Ethiopia?