Key Accounting Principles and Financial Reporting Standards

Posted on Jan 9, 2025 in Economy

Conceptual Framework

Financial Reporting Objectives

To ensure a true and fair view of the economic/financial position and the results of companies in order to help decision-makers (information users).

Qualitative Characteristics

Relevant, Reliable, Comparable, Understandable, Timely, and Verifiable.

Constraints in Financial Reporting

Costs and Materiality, Reliable measurement, and Balance characteristics.

Accounting Principles

Going Concern

Unless there is evidence to the contrary, it shall be presumed that the company will continue operations in the foreseeable future. Thus, the aim of applying this accounting principle is to determine the value of companies’ assets in the case of business continuity (not based on liquidation or net realizable values of assets).

Accrual Basis

The effect of transactions and other economic events shall be recognized when they occur. The related expenses and income shall be recognized in the annual accounts of the reporting period to which they relate, irrespective of the payment or collection date.

Consistency

Once a criterion has been adopted from the available options, this should be maintained over time and applied in the same way to other similar transactions. Companies may change accounting criteria, but in that case, it has to be clearly explained why the company did so in the Complementary Notes (memoria).

Prudence

Only profits obtained before the end of the reporting period shall be recognized. However, all risks (liabilities) arising during the current or prior reporting periods should be taken into consideration as soon as they become known. This Accounting Principle may seem in contradiction with the Accrual Basis Accounting Principle (which actually refers to the fact that revenues and expenses should be recorded when they occur, not when are collected or paid).

Offsetting

Assets and liabilities, and income and expenses, shall not be offset unless expressly permitted by a standard.

Example:

If a company has Accounts Receivables for 10,000 euros and Account Payables for 5,000 euros, it cannot offset both amounts and only record Accounts Receivables for 5,000 euros (not even in the case the amounts were the same and/or the debtor/creditor was the same entity).

Materiality

Strict application of certain accounting principles and criteria may be waived when the quantitative variation arising … does not significantly affect the true and fair representation of the company’s economic and financial situation. When items are not material (not significant) they may be aggregated with other similar items of greater magnitude.

Elements of Financial Statements

Recognition Criteria

An item that meets the definition of an element should be recognized if:

  • It is highly probable that economic benefits will flow into or from the company in the future.
  • The item has a cost or value that is reliably measured.

Measurement and Valuation

By default, any item should be valued at Historical Cost (total cost of purchase). Other valuation criteria are:

  • Fair Value: current market value.
  • Net Realizable Value: liquidation value.
  • Book Value: Historical Value – Amortization – Losses
  • Residual Value: liquidation value once the useful life of the item has ended.

Recognition & Measurement

Probable future benefits and Reliable measurement. Value

Annual Accounts

Balance Sheet, Income Statement, Cash Flow, Changes in Equity, and Notes.