cfas chapter 3

• Relevance


  The capacity of the information to influence a decision
• To be relevant, the financial information must be capable of making a difference in the decisions made by users
• Relevance requires that the financial information should be related or pertinent to the economic decision
• Information that does not bear on an economic decision is useless
• To be useful, information must be relevant to the decision making needs of users
• Relevance of financial statements


  • The statement of financial position is relevant in determining financial position
  • The income statement is relevant in determining performance
• Relevance of financial information


  • Earnings per share information is more relevant than book value per share in determining the attractiveness of an investment
• Predictive value


  Financial information can be used as an input to processes employed by users to predict future outcome
• Predictive value of financial information


  • Information about financial position and past performance is frequently used in predicting dividend and wage payments and the ability of the entity to meet maturing commitments
  • The net cash provided by operating activities is valuable in predicting loan payment or default
• Confirmatory value


  Financial information provides feedback about previous evaluations
• Confirmatory value of financial information


  • A net income measure can help shareholders confirm or revise their expectation about an entity's ability to generate earnings
• Often, information has both predictive and confirmatory value
• Predictive and confirmatory value


  • An interim income statement provides feedback about income to date and serves as a basis for predicting the annual income
• Materiality


  A practical rule in accounting which dictates that strict adherence to GAAP is not required when the items are not significant enough to affect the evaluation, decision and fairness of the financial statements
• Materiality is really a quantitative threshold linked very closely to the qualitative characteristic of relevance
• The relevance of information is affected by its nature and magnitude
• The Conceptual Framework does not specify a uniform quantitative threshold for materiality or predetermine what could be material in a particular situation
• Materiality


  Relativity - the materiality of an item depends on relative size rather than absolute size. What is material for one entity may be immaterial for another
• An error of P500,000 in the financial statements of a multinational entity


  May not be important but may be so critical for a small entity
• Determining if an item is material

  • There is no strict or uniform rule - it depends on good judgment, professional expertise and common sense
  • An item is material if knowledge of it could reasonably affect or influence the economic decision of the primary users of the financial statements
• New definition of materiality (IASB)


  Information is material if omitting, misstating or obscuring it could reasonably be expected to influence the economic decisions that primary users of general purpose financial statements make on the basis of those statements
• New definition highlights


  • Could reasonably be expected to influence
  • Obscuring information
  • Primary users
• Could reasonably be expected to influence


  Limits material information to that which could reasonably be expected to influence the economic decisions of primary users, rather than all users
• Obscuring information


  Presenting or communicating information in a way that has a similar effect as omitting or misstating the information, e.g. vagueness, ambiguity, abstruseness
• Primary users


  Existing and potential investors, lenders and other creditors - the users to whom general purpose financial statements are primarily directed
• Other users include employees, customers, government agencies and the public in general
• Factors of materiality


  • Magnitude (relative size of the item compared to the total of the group it belongs to)
  • Nature (the inherent materiality of the item due to its very nature, e.g. a P20,000 bribe is material even for a large entity)
• Faithful representation


  Financial reports represent economic phenomena or transactions in words and numbers, the descriptions and figures must match what really existed or happened
• Ingredients of faithful representation


  • Completeness
  • Neutrality
  • Free from error
• Completeness


  Relevant information should be presented in a way that facilitates understanding and avoids erroneous implication, includes all necessary description and explanation
• Standard of adequate disclosure


  All significant and relevant information leading to the preparation of financial statements shall be clearly reported, disclosure of any financial facts significant enough to influence the judgment of informed users
• Neutrality


  Financial information is without bias in the preparation or presentation, not slanted, weighted, emphasized, de-emphasized or otherwise manipulated, directed to the common needs of many users and not to the particular needs of specific users
• Prudence


  Exercise of care and caution when dealing with the uncertainties in the measurement process such that assets or income are not overstated and liabilities or expenses are not understated
• Conservatism


  When alternatives exist, the alternative which has the least effect on equity should be chosen, "in case of doubt, record any loss and do not record any gain"
• Expressions of conservatism


  • "Anticipate no profit and provide for probable and measurable loss"
  • "In the matter of income recognition, the accountant takes the position that no matter how sure the businessman might be in capturing the bird in the bush, he, the accountant, must see it in the hand"
  • "Don't count your chicks until the eggs hatch"
• Free from error


  No errors or omissions in the description of the phenomenon or transaction. The process used to produce the reported information has been selected and applied with no errors in the process.
• Free from error does not mean accurate in all respects
• Estimate of an unobservable price or value

  • Cannot be determined to be accurate or inaccurate, but a representation of that estimate can be faithful if the amount is described clearly and accurately as an estimate, and the nature and limitations of the estimating process are explained, and no errors have been made in selecting and applying an appropriate process for developing the estimate.
• Measurement uncertainty


  Arises when monetary amounts in financial reports cannot be observed directly and must instead be estimated. Can affect faithful representation if the level of uncertainty in providing an estimate is high.
• The use of reasonable estimate is an essential part of providing financial information and does not undermine the usefulness of the financial information