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Chapter 1 – Financial Reporting – basic concepts

Underlying assumptions
• accruals

• going concern

• consistency

• materiality

• off-setting

E xample 1  

Laima has recently bought a shop called Sweet for $1 million and included the full amount in her cost of sales
account.
How does each of the five concepts affect the way Laima should treat the cost of $1 million?

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2 December 2008 examinations
Chapter 1: Financial Reporting – basic concepts

Advantages and disadvantages of standardisation of accounting practices

• provide a focal point for debate

• require disclosure of policies adopted

• encourage global discussion

• flexible

• enable meaningful comparison

• reduce penumbral areas of divergent possibilities

• pressure groups may succeed in asking for amendments

• allowed alternative treatments – standardisation?

• inappropriate treatment could result from following a standard

• rules take away use of skill and judgement

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 Paper F7 3
Chapter 1: Financial Reporting – basic concepts

A conceptual framework
• framework has been developed

defined as  “a constitution, a coherent system of interrelated objectives and fundamentals which
can lead to consistent standards and which prescribe the nature, function and limits of financial
accounting and financial statements”

• generally accepted accounting practice ( gaap )

• a combination of:

• each country’s own law

• international financial reporting standards

• stock exchange requirements

• but gaap does not have any statutory authority

• changes and evolves with changing circumstances

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4 December 2008 examinations
Chapter 1: Financial Reporting – basic concepts

The framework
• provides a set of principles

• purpose defined as assisting:-

• IASC in development of new standards

• review of existing standards

• harmonisation of standards and procedures

• reduction of penumbral areas of divergent possibilities

• development of new standards by national accounting bodies

• preparers of financial statements

• auditors in forming audit opinions

• users in their interpretation of financial statements

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Chapter 1: Financial Reporting – basic concepts

Framework contents
• objectives of financial statements

• underlying assumptions ( accruals and going concern )

• qualitative characteristics ( see next )

• elements of financial statements (assets, liabilities, equity, income, expenses and capital
maintenance)

• recognition of the elements

• measurement

• concept of capital and capital maintenance

• as a set of principles, it requires entities to follow the spirit of the framework

• it’s not a standard, so does not override any existing standard requirements

• nor does it define any standard for measurement or disclosure of any particular issue

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6 December 2008 examinations
Chapter 1: Financial Reporting – basic concepts

Framework – qualitative characteristics

• understandable

• comparable

• relevant

• faithful representation

• complete

• material

• substance over form

• reliable

• neutral

• prudent

(you can remember framework contents. Mike says remember nine principles!)

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