Chapter 2_Notes

Chapter 2_Notes - CHAPTER 2 NOTES Relevance and reliability are the two primary qualitative characteristics that make accounting information useful

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CHAPTER 2 NOTES Relevance and reliability are the two primary qualitative characteristics that make accounting information useful for decision making. Relevant information refers to information that is capable of influencing “the decisions of users by helping them evaluate the financial impact of past, present or future transactions and events or confirm, or correct, previous evaluations.” 1 Relevance has two main aspects: predictive value and feedback value. Predictive value refers to the usefulness of information for predictions of an entity's future income and cash flows. Feedback value concerns confirming or correcting previous predictions. 2 Reliable information refers to information that faithfully represents without bias what it is intended to represent. Reliability has three main dimensions: Representational faithfulness is achieved if the accounting evaluation or description of an item is in agreement with the real item the information represents. Verifiability is achieved when knowledgeable and independent observers (e.g., accountants and auditors) are able to come up with the same value. Neutrality is achieved when accounting valuation is free of bias (e.g. free from management manipulation). In practice, there is a tradeoff between relevance and reliability. Ideal conditions under certainty Characterized by: Known future cash receipts Given interest rate Ideal conditions under uncertainty Characterized by: a given fixed interest rate a complete and publicly known set of states of nature objective and publically known state probabilities publically observable state realization 1 CICA Handbook Section 1000 Financial Statement Concepts , para. .20 2 Ibid.
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Chapter 2 Notes assumption – investors are risk-neutral and the state realizations are independent (to eliminate complications) Present value model under certainty The net book value of capital assets at year-end equals its fair value (amortization
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This note was uploaded on 12/14/2010 for the course ACC 706 taught by Professor Shadifarshad during the Winter '09 term at Ryerson.

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Chapter 2_Notes - CHAPTER 2 NOTES Relevance and reliability are the two primary qualitative characteristics that make accounting information useful

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