Chapter 2: The Chapter 2: The Conceptual FrameworkConceptual Framework

• The Framework was to be the foundation for building a set of coherent accounting standards and rules.

• The Framework is to be a reference of basic accounting theory for solving emerging practical problems of reporting.

Objectives of the Objectives of the Conceptual FrameworkConceptual Framework

• The FASB has issued seven Statements of Financial Accounting Concepts (SFACs) to date (Statements 1 through 7.)

• These statements set forth major recognition and reporting issues.

• Statement 4 pertains to reporting by non-business entities.

• The other six statements pertain to reporting by business enterprises.

Statements of Financial Statements of Financial Accounting ConceptsAccounting Concepts

• Statement 1

• Statement 2

• Statement 6

• Statement 4

• Statement 5

• Statement 7

• Objectives of Financial (FIN) Reporting

• Qualitative Characteristics

• Elements of FIN Statements

• Objectives of FIN Reporting (Non-business)

• Recognition and Measurement Criteria

• Using Cash Flows

Brief TitleStatement

Statements of Financial Statements of Financial Accounting ConceptsAccounting Concepts

Examines the characteristics that make accounting info useful and expands 3 to include not-for-profit orgs.

Presents the goals and purposes of accounting.

Examines the characteristics that make accounting information useful.

Guidance on what info should be formally incorporated into financial statements and when

Provides a framework for using expected future cash flows and present value as a basis for measurement

Guidelines for not-for-profit and governmental entities.

The Framework has three different levels,comprised

of:

Overview of the Overview of the Conceptual FrameworkConceptual Framework

Conceptual Framework Conceptual Framework for Financial Reportingfor Financial Reporting

Chapter 1:Objectives: (1) Useful in investment and credit decisions (2) Useful in assessing future cash flows (3) About enterprise resources, claims to resources and changes in them

Chapter 2

Conceptual Framework Conceptual Framework for Financial Reportingfor Financial Reporting

What are these qualitative characteristics?

• Primary qualities of accounting information are relevance and reliability.

• Secondary qualities are comparability and consistency of reported information.

Qualitative Qualitative Characteristics of Characteristics of

Accounting InformationAccounting Information

“Relevance of information means information ccapable of making a difference in a decision

context.”

Ingredients of relevant information are:• Timeliness• Predictive value - • Feedback value – allows users to confirm or

correct prior expectations

Primary Characteristic of Primary Characteristic of Accounting Information: Accounting Information:

RelevanceRelevance

Information is Reliable when it can be relied on to represent the true,

underlying situation.

The ingredients of reliable information are:

• verifiability• representational faithfulness• neutrality (unbiased)

Primary Characteristic of Primary Characteristic of Accounting Information: Accounting Information:

RelevanceRelevance

Comparability: the similar measurement and reporting for different enterprises.

Consistency: application of the same accounting treatment to similar events by an enterprise from period to period.

Secondary Characteristics Secondary Characteristics of Accounting Informationof Accounting Information

Conceptual Framework Conceptual Framework for Financial Reportingfor Financial Reporting

What are these Elements?

• Assets• Liabilities• Equity• Investment

by Owners• Distributions

to Owners

• Comprehensive Income

• Revenues• Expenses• Gains• Losses

Basic Elements of Basic Elements of Financial StatementsFinancial Statements

Conceptual Framework Conceptual Framework for Financial Reportingfor Financial Reporting

What are these Recognition & Measurement Issues?

BasicAssumptions

1. Economic entity 2. Going concern 3. Monetary

unit4. Periodicity

Principles

1. Historical cost

2. Revenue recognition

3. Matching4. Full

disclosure

Constraints

1. Cost benefit2. Materiality3. Industry practices4. Conservatism

Recognition and Recognition and Measurement CriteriaMeasurement Criteria

• Periodicity Assumption

AssumptionsAssumptions

The life of an economic entity can be divided into artificial time periods for the purpose of providing periodic reports on the economic activities of the entity.

• Monetary Unit Assumption

• Going Concern Assumption

• Economic Entity

Assumes that money is the common denominator of economic activity for financial reporting.

In the absence of contrary information, a business entity is assumed to have a long life.

This is why plant assets are not reported at liquidation value.

Indicates the entity is separate and distinct from its owners or other business units.

• Full Disclosure Principle

PrincipalsPrincipals

In the preparation of financial statements, the accountant should include sufficient information to permit the knowledgeable reader to make an informed judgment about the financial condition of the enterprise in question.

• Matching Principle

• Revenue Recognition Principle

• Historical Cost Principle

Allocates expenses to revenues in the proper period

Revenue is recognized (1) when realized or realizable and (2) when earned.

1.) Assets & Liabilities are accounted for based on acquisition cost

2.) Why? Cost has been found to be a more stable and consistent benchmark than other suggested valuation methods

3.) Consequence? Subsequent MV changes are NOT recorded in the accounts

• Conservatism

ConstraintsConstraints

When in doubt, an accountant should choose a solution that will be least likely to overstate assets and income. The conservatism constraint should be applied only when doubt exists. An intentional understatement of assets or income is not acceptable accounting.

• Industry Practices

• Materiality

• Cost-Benefit Relationship

Basic accounting theory may not apply with equal relevance to every industry that accounting must serve. The fair presentation of financial position and results of operations for a particular industry may require a departure from basic accounting theory because of the peculiar nature of an event or practice common only to that industry.

In the application of basic accounting theory, an amount may be considered less important because of its size in comparison with revenues and expenses, assets and liabilities, or net income. Deciding when an amount is material in relation to other amounts is a matter of judgment and professional expertise.

This constraint relates to the notion that the benefits to be derived from providing certain accounting information should exceed the costs of providing that information. The difficulty in cost-benefit analysis is that the costs and especially the benefits are not always evident or measurable.

SummarySummary

Assumptions: (1) Economic entity (2) Going concern (3) Monetary unit (4) Periodicity

Principals: (1) Historical Cost (2) Revenue recognition (3) Matching (4) Full Disclosure

Constraints: (1) Cost-benefit (2) materiality (3) Industry practice (4) Conservatism

Objectives: (1) Useful in investment and credit decisions (2) Useful in assessing future cash flows (3) About enterprise resources, claims to resources and changes in them

Qualitative Characteristics: Primary: Relevance and Reliability Secondary: Comparability and Consistency

Elements

Assets, Liabilities, Equity

Investment/Distribution by owners

Comprehensive Income

Revenues, Expenses

Gains, Losses