Financial Accounting Fundamentals

McGraw-Hill/Irwin

Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Accounting is a service activity. Its function is to provide qualitative information,

primarily financial in nature, about economic entities, that is intended to
be useful in making economic decision.

is the art of recording, classifying and summarizing in a significant

manner and in terms of money, transactions and events which are in part
at least of a financial character and interpreting the results thereof.

is the process of identifying, measuring and communicating economic

information to permit informed judgment and decision by users of the
information.

Accounting Is to provide qualitative information to be useful in making an

economic decision.

Republic Act No. 9298

Philippine Accountancy Act of 2004 a law regulating the practice of
accountancy in the Philippines
In order to qualify to practice the accountancy profession : Finish a
degree in BSA and pass the CPA Board Examination.

Board of Accountancy (BOA)

Is the body authorized by law to promulgate rules and regulations
affecting the practice of the accountancy profession in the
Philippines.
Responsible for preparing and grading the Philippines CPA
examination. (May and October)

Three main areas generally practice

by CPAs
Public Accounting

Private Accounting
Government Accounting

Public Accounting
Composed of individual practitioner, small accounting firms and large
multinational organizations that render independent and expert
financial services to the public.
3 services: auditing, taxation and management advisory services.

Private Accounting
CPAs are employed in business entities in various capacity as
accounting staff, chief accountant, internal auditor and controller.
The major objective is to assist management in planning and
controlling the entitys operations.

Government Accounting
Encompasses the process of analyzing, classifying, summarizing and
communicating all transactions involving the receipt and disposition of
government funds and property and interpreting the results thereof.
Custody and administration of public funds.

GENERALLY ACCEPTED ACCOUNTING PRINCIPLE

(GAAP)
rules, procedures, practices and standards followed in the
preparation and presentation of financial statements.
like laws that must be followed in financial reporting.

FINANCIAL REPORTING STANDARD

COUNCIL (FRSC)
main function is to establish and improve accounting standards that
will be generally accepted in the Philippines.
Philippine Accounting Standards (PAS) and Philippine Financial
Reporting Standards (PFRS) are the approved statements of the FRSC.

FRSC is composed of 15 members

Chairman senior accounting practitioner

1
Board of Accountancy
1
SEC
1
BSP
1
BIR
1
COA
1
Major organization of preparers and users of
financial statements
1
Accredited National Professional Organization of CPAs
Public Practice
2
Commerce and Industry
2
Academe or Education
2
Government
2
-----------------------

15

Philippine Interpretation
Committee ( PIC)
To prepare interpretations of PFRS for the approval of Financial
Reporting Standard Council and in the context of Conceptual
Framework, to provide timely guidance on financial reporting issues
not specifically addressed in current PFRS.

International Accounting Standard Committee (IASC)

Is an independent private sector body, with the objective of
achieving uniformity in the accounting principle which are
used by business and other organizations for financial
reporting around the world.

OBJECTIVES
To formulate and publish in the public interest accounting standards to
be observed in the presentation of financial statements and to
promote their worldwide acceptance and observance.
To work generally for the improvement and harmonization of
regulations, accounting standards and procedures relating to the
presentation of financial statements.

International Accounting Standard Board

(IASB)
Publishes its standards in a series of
pronouncement called International Financial
Reporting Standards or IFRS.
Philippine Financial Reporting Standards (PFRS)

Underlying Assumptions
Going Concern
Accounting Entity
Time Period
Monetary Unit

GOING CONCERN
means that in the absence of evidence to the contrary, the
accounting entity is viewed as continuing in operation indefinitely.
Assets are normally recorded at cost

Accounting Entity
The entity is separate from the owners, managers and employees
who constitute the entity.
Fair Presentation of Financial Statements

Time Period
requires that the indefinite life of the entity is subdivided into time
periods or accounting periods which are usually of equal length for
the purpose of preparing financial reports on financial positions,
performance and cash flows.

Monetary Unit
Two aspects:
Quantifiability aspects means

that the assets, liabilities, equity,

income and expenses should be stated in terms of unit of
measure which is the peso in the Philippines.
Stability of peso assumption means that the purchasing power
of the peso is stable or constant and that its instability is
insignificant and therefore may be ignored.

CONCEPTUAL FRAMEWORK

is a summary of the terms and concepts that

underlie the preparation and presentation of
financial statements for external users.

to provide overall theoretical foundation for

accounting which will guide standard-setters,
preparers and users of financial information in the
preparation and presentation of statements.

Purpose of Conceptual Framework

A. To assist the FRSC in developing accounting standards that will
represent Philippine GAAP.
B. To assist preparers of financial statements in applying
accounting standards and in dealing with issues not yet covered by
GAAP.
C. To assist the FRSC in its review and adoption of International
Financial Reporting Standards.
D. To assist users of financial statements in interpreting the
information contained in the financial statements.
E. To assist auditors in forming an opinion as to whether financial
statements conform with Philippine GAAP.
F. To provide information to those interested in the work of the
FRSC in the formulation of PFRS.

Authoritative Status of Conceptual Framework

Standard or an interpretation that specifically applies to
a transaction, the standard or interpretation overrides
the Conceptual Framework.
In the absence of standard or an interpretation that
specifically applies to a transaction, management shall
consider the applicability of the Conceptual Framework
in developing and applying an accounting policy that
results in information that is relevant and reliable.

Users of Financial Information

A. Primary Users - include the existing and potential investors,
lenders and other creditors.
B. Other Users include the employees, customers, governments
and their agencies and the public.

Scope of Conceptual Framework

A. Objective of Financial Reporting
B. Qualitative Characteristics of useful Financial
Information
C. Definition, recognition and measurement of the
elements from which financial statements are
constructed
D. Concepts of capital and capital maintenance

A. Objective of Financial Reporting

Is 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.

B. QUALITATIVE CHARACTERISTICS
The qualities or attributes that make financial accounting information useful to the users.
Two Classification of Qualitative Characteristics
1.
Fundamental Qualitative Characteristics
2.
Enhancing Qualitative Characteristics

Fundamental Qualitative Characteristics relate to

content or substance of financial information

A. Relevance capacity of the information to influence a decision.

Is capable of making difference in a decision if it has predictive value and confirmatory
value.

Predictive value it can help the users increase the likelihood of

correctly or accurately predicting or forecasting outcome of events.
Confirmatory Value if it provides feedback about previous
evaluations.

Ingredient of Relevance
Materiality- a qualitative threshold linked very closely to the

qualitative character of relevance. A subquality of relevance

based on the nature or magnitude or both of the items to
which the informations relates.

b. Faithful representation
Other term for reliability
Means that the actual effects of the transactions shall be
properly accounted for and reported in the financial
statements.
Ex. If the entity reports purchases of P5,000,000 when the actual
amount is P8,000,000, the information would not be faithfully
represented.

Ingredients of Faithful Representation

A. Completeness
B. Neutrality
C. Free from error

a. Completeness
is the result of adequate disclose standard or the principle of

full disclosure. - disclosure of any financial facts significant

enough to influence the judgment of informed users.
NOTES TO FINANCIAL STATEMENTS a narrative description of
disaggregation of the items presented in the financial statements and
information about items that do not qualify for recognition.

b. Neutrality
Is without bias in the preparation and presentation of
financial information.

c. Free from error

No errors or omissions in the description of the
phenomenon or transaction, and the process used to
produce the reported information has been selected
and applied with no errors in the process.

Old Framework includes the following as aspect of

reliability
1. substance over form

2. Prudence or conservatism

Enhancing qualitative characteristics - relate to the

presentation or form of the financial information.

A. Comparability
B. Understandability
C. Verifiability
D. Timeliness

A. Comparability
- enables users to identify and understand similarities and dissimilarities
among items;

Comparability may be within an entity or between and across

entities.

Consistency requires that the accounting methods and practices

should be applied on a uniform basis from period to period. Is a
uniform application of accounting method from period to period
across entities.

B. Understandability
- Information should be presented in a form and
expressed in terminology that user understand.
Classifying, characterizing and presenting information
clearly and concisely make it understandable.

C. Verifiability
-Means that different knowledgeable and independent
observers could reach consensus, although not necessarily
complete agreement, that a particular depiction is a faithful
presentation.

D. Timeliness
- financial information must be available or communicated early enough
when a decision is to be made.

Relationship between financial statements

Annual Accounting Period
19A

Jan. 1
19B
Balance
Sheet
(Begin)

Dec. 31
19B
Income
Statement

Balance
Sheet
(End)

Assets

Assets

Liabilities

Liabilities

Owners Equity

Net Income

Owners Equity

Statement of Cash Flows

Increase or Decrease in cash

19C

C1

Importance of Accounting
is a
Accounting

system that

Identifies

Records
information

Relevant

that is

Communicates

Reliable
Comparable

about an
organizations
business activities.
1-41

C1

Accounting Activities
Identifying
Business
Activities

Recording
Business
Activities

Communicating
Business
Activities

1-42

C2

Users of Accounting Information

Internal Users
External Users

Lenders

Consumer Groups

Managers

Sales Staff

Shareholders External Auditors

Officers

Budget Officers

Governments Customers

Internal Auditors Controllers

1-43

C2

Users of Accounting Information

External Users

Internal Users

Financial accounting provides

external users with financial
statements (shareholders,
lenders, etc.).

Managerial accounting provides

information needs for internal
decision makers (officers,
managers, etc.).
1-44

Opportunities in Accounting
Financial
Preparation
Analysis
Auditing
Regulatory
Consulting
Planning
Criminal
investigation

Accountingrelated

Managerial
General accounting
Cost accounting
Budgeting
Internal auditing
Consulting
Controller
Treasurer
Strategy
Lenders
Consultants
Analysts
Traders
Directors
Underwriters
Planners
Appraisers

Taxation
Preparation
Planning
Regulatory
Investigations
Consulting
Enforcement
Legal services
Estate plans
FBI investigators
Market researchers
Systems designers
Merger services
Business valuation
Forensic accountant
Litigation support
Entrepreneurs
1-45

C4

Business Entity Forms

Sole
Proprietorship

Partnership

Corporation

1-46

A1

Accounting Equation

Assets

Liabilities

Assets

Equity

Liabilities
+ Equity

1-47

Elements of Financial Statements

Assets resources controlled by the entity as a result of past transactions
or event and which future economic benefits are expected to flow to the
entity.
Liabilities - present obligation of the entity arising from past transactions
or events the settlement of which is expected to result in an outflow from
the entity of resources embodying economic benefits.
Equity residual interest in the assets of the entity after deducting all of
its liabilities.
Income Increase in economic benefit during the accounting period in
the form of inflow or increase in asset or decrease in liability that results
in increase in equity, other than contribution from equity participants.
Expense - decrease in economic benefit during the accounting period in
the form of outflow or decrease in asset or increase in liability that
results in decrease in equity, other than distribution from equity
participants.

C4

Principles and Assumptions

Accounting

Measurement principle (also called

cost principle) means that accounting
information is based on actual cost.

of

Going-concern assumption means

that accounting information reflects a
presumption the business will
continue operating.

Revenue recognition principle

provides guidance on when a
company must recognize revenue.

Monetary unit assumption means we

can express transactions in money.

Matching principle (expense

recognition) prescribes that a
company must record its expenses
incurred to generate the revenue.

Time period assumption presumes

that the life of a company can be
divided into time periods, such as
months and years.

Full disclosure principle requires a

company to report the details behind
financial statements that would impact
users decisions.

Business entity assumption means

that a business is accounted for
separately from its owner or other
business entities.
1-49

A1

Assets
Cash

Accounts
Receivable

Vehicles

Store
Supplies

Resources
owned or
controlled
by a
company

Notes
Receivable

Land

Buildings
Equipment
1-50

A1

Liabilities

Accounts
Payable

Notes
Payable

Creditors
claims on
assets
Taxes
Payable

Wages
Payable

1-51

A1

Equity
Retained
Earnings

Contributed
Capital

Owners
claim on
assets

Dividends
1-52

A1

Expanded Accounting Equation

Assets
Assets

Contributed
Capital

=
=
_

Liabilities
Liabilities

Dividends

+
+
Revenues

Equity
Equity

_ Expenses

Retained Earnings
1-53

Objective of financial reporting

54

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 information provided about financial performance helps existing and
potential investors, lenders and other creditors to understand the return
the entity has produced on its economic resources.

Objective of financial reporting continued

55

Decisions by investors about buying, selling or holding

equity and debt instruments depend on the returns that
they expect from an investment in those instruments, eg
dividends, principal and interest payments or market price
increases.
Decisions by lenders about providing or settling loans and
other forms of credit depend on the principal and interest
payments or other returns that they expect.
Information must reflect the effect on performance of
changes in market prices and/or interest rates.

Objective of financial reporting continued

56

Information about an entitys financial

performance in a period, reflected by changes in
economic resources (other than by obtaining
additional resources directly from investors or
creditors) is useful in assessing the entitys past and
future ability to generate net cash inflows

Fundamental Concepts
Qualitative Characteristics
The FASB identified the Qualitative Characteristics of

accounting information that distinguish better (more useful)

information from inferior (less useful) information for
decision-making purposes.

FINANCIAL STATEMENTS

P2

Financial Statements
Lets prepare the Financial Statements reflecting the transactions we
have recorded.

1. Income Statement
2. Statement of Retained Earnings

3. Balance Sheet
4. Statement of Cash Flows

1-59

P2

Income Statement
DLSL Company
Income Statement
For Month Ended December 31, 2013
Revenues:
Consulting revenue
Expenses:
Salaries expense
Net income

3000.00
800.00
2200.00

Net income is the

difference
between
Revenues and
Expenses.

The income statement describes a

companys revenues and expenses along
with the resulting net income or loss over a
period of time due to earnings activities.
1-60

P2

Statement of Retained Earnings

DLSL Company
Income Statement
For Month Ended December 31, 2013
Revenues:
Consulting revenue
Expenses:
Salaries expense
Net income

3,000.00

The net income of

P2,200 increases
Retained Earnings by
P2,200.

800.00
2,200.00

DLSL Company
Statement of Retained Earnings
For Month Ended December 31, 2013

Retained Earnings, Dec. 1, 2013

Plus: Net income
Less: Dividends
Retained Earnings, Dec. 31, 2013

0.00
2200.00
500.00
1700.00
1-61

P2

Balance Sheet
The Balance Sheet describes
a companys financial position
at a point in time.
DLSL Company
Balance Sheet
December 31, 2013
Assets

Cash
Supplies
Equipment

Total assets

9,700.00
1,200.00
16,000.00

26,900.00

DLSL Company
Statement of Retained Earnings
For Month Ended December 31, 2011
Retained Earnings, Dec. 1, 2013
Plus: Net income
Less: Dividends
Retained Earnings, Dec. 31, 2013

Liabilities
Accounts payable
Notes payable
Total liabilities
Equity
Common stock
Retained earnings
Total liabilities and equity

0.00
2200.00
500.00
1700.00

1,200.00
4,000.00
5,200.00
20,000.00
1,700.00
26,900.00
1-62

Statement of Cash Flows

P2

DLSL Company
Statement of Cash Flows
For Month Ended December 31, 2013
Cash flows from operating activities:
Cash received from clients
Purchase of supplies
Cash paid to employees
Net cash provided by operating activities
Cash flows from investing activities:
Purchase of equipment
Net cash used in investing activities
Cash flows from financing activities:
Investment by Shareholders
Borrowed at bank
Dividends Paid
Net cash provided by financing activities
Net increase in cash
Cash balance, December 1, 2013
Cash balance, December 31, 2013

3,000.00
(1,000.00)
(800.00)
1,200.00
(15,000.00)
(15,000.00)
20,000.00
4,000.00
(500.00)
23,500.00
9,700.00
9,700.00
1-63

Recognition and Measurement

Elements of Financial Statements
AcSB, an element should be included in the accounts when
The item meets the definition of an element.
The item has an appropriate basis of measurement, and a reasonable estimate can be made
of the amount.
For assets and liabilities, it is probable that the economic benefits will be received or given
up.

Measurability is important.
If an item cannot be measured, it cannot be recognized, even
if it has a high probability of being realized.

Balance Sheet
Elements
Assets are economic resources controlled by
an entity as a result of past transactions or
events from which future economic benefits
may be obtained

Transaction Characteristics
To qualify as assets, the resources involved
must
1. Have future economic benefits;
2. Be under the entity's current control and
3. Result from past transactions
Liabilities are obligations of an entity arising
To qualify as liabilities, obligations must:
from past transactions or events, the settlement 1. Require future transfer of assets or
of which will result in the transfer or use of
economic benefits
assets, provision of services, or other yielding 2. Be an unavoidable current obligation
of economic benefits in the future
3. Result from past transactions
Owners equity/net assets is the ownership
interest in the assets of an entity after
deducting its liabilities. While equity in total is
a residual, it includes specific categories of
items - for example, types of share capital,
other contributed capital, and retained
earnings.

The dollar amounts reported represent the

residual interest in the assets after deducting
the liabilities. In addition, the equity element
is used to report capital transactions
Source: CICA Handbook, Financial
Statement Concepts, Section 1000.

Definitions of Income Statement Elements

Revenues are increases in net assets, either by way
of inflows or enhancements of assets or reductions
of liabilities, resulting
the ordinary
of
from thefrom
ordinary
fromactivities
peripheral
the enterprise. activities of
or incidental
Expenses are decreases
in net
either by way
the enterprise
. assets,transactions.
of outflows or reductions of assets or incurrences of
liabilities, resulting from an enterprises ordinary
revenue
or service delivery activities.
Gains
Increases
in generating
Revenues
Gains
are
increases
in
net
assets
from
peripheral
or
net assets
incidental transactions.
Losses
in net assets fromLosses
peripheral
Decreases
inare decreases
Expenses
or incidental transactions.

net assets

Recognition, Realization, and Accrual

Recognition is the process of measuring and
including an item in the financial statements.
The item is given a title
and a numerical value.
Recognition applies to
all financial statement elements in
all accounting entities.
Disclosure
(in the notes to the financial statements) is
not recognition; when a financial statement
element is recognized, it is reported on the
face of the financial statements.

THANK YOU

Recognition, Realization, and Accrual

Realization
is the process of converting an asset,
liability, or commitment into a cash flow.
A receivable is said to be realized when
it is collected;
Revenues are realized when received;
Expenses and liabilities are realized
when the cash payment occurs.
Once realization has occurred, recognition
must occur because there has been a cash
flow impact that cannot be ignored in the accounts.

Recognition, Realization, and Accrual

When we recognize the effects of transactions and events prior to
their realization, we are using the accrual concept.
we recognize assets when we have the
right to receive their benefits, and
we recognize liabilities when we take
on the obligation to deliver cash (or
other assets) or services in the future.
Accrual does not refer to the subsequent
transfer of amounts from the balance
sheet to the income statement, which
is a secondary form of recognition

Recognition, Realization, and Accrual

Recognition
Examples:often occurs prior to realization. For example:
A customer
makes aisdeposit
(or pays
in advance)
Anaccounts
receivable
recognized
when
a service for
hasgoods
been yet
to be produced
and
delivered;
sincewhen
the cash
been
performed
for a client;
realization
occurs
the has
client
pays the
received
(realized),
it must berevenue.
recognized. Since revenue will
account.
The offset
is to recognize
not yet have been earned, the offsetting credit is to recognize
A liability for a purchase of inventory is recognized when the
unearned revenue.
goods are received; realization occurs when the creditor is paid. The
A company pays a retainer to a lawyer who will be acting on
offset the
is tocompanys
recognize behalf
inventory
as an
asset.
in the
next
fiscal year; the cash outflow
The triggers
liability recognition
for a purchase
new equipment
of aof
prepaid
expense. is recognized; the
liability is offset by an increase in an asset account (i.e., equipment).
Unpaid wages are accrued at the end of a fiscal period; a liability is
recognized. The liability is offset by a debit to an expense account.

Measurement Conventions
Measurement is the process of determining the amount at which an item is
recognized in the financial statements.
Measurement methods encompass not only the process of attaching a number
to a construct but also the process of income measurement
The process of income measurement involves not only the initial measurement,
but also the disposition of that measurement as it moves through the financial
statements.
Historical Cost Convention
Revenue Recognition Convention
Matching Convention
Full Disclosure

Historical Cost Convention

The historical cost convention specifies that the actual
acquisition cost be used for initial accounting recognition
purposes.
The cost principle assumes that assets are acquired in
business transactions conducted at arm's length
If an asset is acquired via some means other than cash, the
cost of the asset is based on the value of the consideration
given.
Consideration is whatever the buyer gives the seller.
The cost principle provides guidance primarily at the initial
acquisition date

Revenue Recognition Convention

The revenue recognition convention requires the recognition and
reporting of revenues when all three of the recognition criteria
definition, measurability and probability are met
Traditionally, four conditions have to be met to satisfy the revenue
recognition convention:
All significant acts required of the seller have been performed.
Consideration is measurable.
Collection is reasonably assured.
The risks and rewards of ownership have passed to the buyer.

Matching Convention
Matching - all expenses incurred in earning revenue should be recognized in the
same period that the revenue is recognized. For example:
If revenue is carried over (deferred) for recognition in a future period, any
related expenses should also be carried over or deferred, since they are
incurred in earning that revenue.
If revenue is recognized in the current period but there are expenditures yet to
be incurred in future periods, the expenses are recognized and a liability is
created (e.g., the estimated provision for warranty costs).
If costs are incurred to enhance the general revenue-generating ability of the
company in future periods and the future benefits are measurable, the costs
are capitalized and amortized.

Full Disclosure
Full disclosure means that the financial statements should report all relevant
information bearing on the economic affairs of a business enterprise.
A useful guide to deciding what to disclose is as follows:
Disclose items not in the regular or
normal activities of the business.
Disclose items reflecting changes
in expectations.
Disclose that which a statute or
contract requires to be disclosed.
Disclose new activities or major
changes in old ones.

Making Choices In Accounting: The Exercise Of

Professional Judgement
Professional judgement permeates the work of a
professional accountant, and it involves an ability to
build accounting measurements that take into account:
the objectives of financial reporting in each particular situation,
the facts of the business environment and operations, and
the organizations reporting constraints (if any).

Choices of accounting policies, accounting estimates,

and accounting measurement methods are then based
on tests of the validity of the underlying assumptions,
followed by an evaluation of the various possible
measurement methods with reference to the qualitative
characteristics.

SUMMARY OF KEY POINTS

Accounting

principles consist of three different set of concepts: (1)

underlying assumptions, (2) measurement methods, and (3) qualitative
criteria.

Underlying

assumptions include the basic postulates which make accounting

measurements possible (such as the separate entity assumption, the unit of
measure concept, and the time period assumption), but they also include
underlying measurement assumptions that usually, but not always, are true
in a given reporting situation. These measurement assumptions include the
going concern assumption, the proprietary assumption, and the nominal
dollar capital maintenance concept.

Qualitative

criteria are the criteria which are used in conjunction with an

enterprises financial reporting objectives to determine the most appropriate
measurement methods to use in that particular reporting situation.

SUMMARY OF KEY POINTS

The most important qualitative criterion is that of relevance; relevance
should be determined with reference to the users of the financial
statements and the resultant financial reporting objectives.
Some qualitative criteria conflict with each other. For example, the most
relevant measurement in a particular situation may not be sufficiently
objective to permit its use.
Objectivity is a general concept that has several components, including
measurability, verifiability, freedom from bias, and reliability.
The role of conservatism in accounting is to ensure that the
uncertainties and risks inherent in measuring the effects of any given
business situation are given adequate consideration. Conservatism
should not be used as a justification for overstating liabilities or
understating assets.

SUMMARY OF KEY POINTS

Measurement methods are the various ways that the results of transactions
and events can be reported in the financial statements. There is a group of
widely-used measurement methods that can be called measurement
conventions, but they are not universally applicable. Measurement
conventions include historical cost, the revenue recognition convention,
matching, and full disclosure.
The elements of financial statements are the seven types of accounts that
appear on the balance sheet and income statement: assets, liabilities,
owners equity, revenues, expenses, gains, and losses.
Initial accounting recognition occurs when the effects or results of a
transaction or event are first measured and assigned to an account or
element. Subsequent recognition occurs when an amount previously
recognized is transferred from one element to another, such as by
recognizing an expense that previously had been recognized as an asset.

SUMMARY OF KEY POINTS

Recognition of an asset or liability requires that three time
references be present: a future benefit or sacrifice and a
present right or obligation, arising from a past transaction
or event.
Realization occurs when a cash flow occurs. Realization
often occurs after recognition, but can never occur prior to
recognition because the cash flow forces recognition if it
has not occurred previously.
The accrual concept relates to the recognition of
receivables when the right to receive cash arises,
and to the recognition of liabilities when the obligation
is created. Accrual does not refer to subsequent secondary
recognition through interperiod allocations.

SUMMARY OF KEY POINTS

Accounting is full of choices. This series of related decisions is what
constitutes professional judgement in accounting. The choice process
includes these elements:
(1) financial statements are constructed from
(2) the financial statement elements that have
been recognized (3) using measurement methods
that (4) optimize the qualitative characteristics and
that (5) are based on the appropriate underlying
assumptions which reflect the organizations
(6) reporting constraints and (7) the facts of its
business and environment, and that provide
information that (8) best satisfies the objectives
of financial reporting in any given situation.

Qualitative Characteristics

Illustration 2-2
Hierarchy of
Accounting Qualities

Qualitative Characteristics
Fundamental QualityRelevance

To be relevant, accounting information must be capable of

making a difference in a decision.

Qualitative Characteristics
Fundamental QualityRelevance

Financial information has predictive value if it has value as an

input to predictive processes used by investors to form their own
expectations about the future.

Qualitative Characteristics
Fundamental QualityRelevance

Relevant information also helps users confirm or correct prior

expectations.

Qualitative Characteristics
Fundamental QualityRelevance

Information is material if omitting it or misstating it could

influence decisions that users make on the basis of the reported
financial information.

Qualitative Characteristics
Fundamental QualityFaithful Representation

Faithful representation means that the numbers and

descriptions match what really existed or happened.

Qualitative Characteristics
Fundamental QualityFaithful Representation

Completeness means that all the information that is necessary

for faithful representation is provided.

Qualitative Characteristics
Fundamental QualityFaithful Representation

Neutrality means that a company cannot select information to

favor one set of interested parties over another.

Qualitative Characteristics
Fundamental QualityFaithful Representation

An information item that is free from error will be a more

accurate (faithful) representation of a financial item.

Qualitative Characteristics
Enhancing Qualities

Information that is measured and reported in a similar manner

for different companies is considered comparable.

Qualitative Characteristics
Enhancing Qualities

Verifiability occurs when independent measurers, using the

same methods, obtain similar results.

Qualitative Characteristics
Enhancing Qualities

Timeliness means having information available to decisionmakers before it loses its capacity to influence decisions.

Qualitative Characteristics
Enhancing Qualities

Understandability is the quality of information that lets

reasonably informed users see its significance.