Chapter 10: Conceptual Framework Chapter 10 1991–2009 ... analyze financial statements. ......

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Transcript of Chapter 10: Conceptual Framework Chapter 10 1991–2009 ... analyze financial statements. ......

  • 1

    19912009 NavAcc LLC, G. Peter & Carolyn R. Wilson

    Chapter 10: Conceptual Framework

    Chapter 10 NavigatiNg aCCouNtiNgs CoNCeptual Framework

    TABLE OF CONTENTS

    Introduction 3

    Business Decisions and Performance 4

    Introduction 4

    What Does it Mean to Say that a Business Performs? 4

    Performance Challenges 5

    Goals and Strategies 7

    Resources 7

    Performance Units 8

    Organized by Functional Specialty 9

    Organized by Lines of Business 9

    Organized by Location 10

    Organized by Key Processes 10

    Internal Alignment 11

    Management Structures and Internal Reports 12

    External Alignment 13

    Legal Structures and External Reports 13

    Timing 15

    Business Decisions Review-Preview 16

  • 2

    19912009 NavAcc LLC, G. Peter & Carolyn R. Wilson

    Navigating Accounting

    Accounting Decisions 23

    Introduction 23

    Decision-Making Hierarchies 23

    Tax Reporting 24

    Financial Reporting 24

    Managerial Reporting 24

    Purposes of Reports 25

    Structure of Reports 25

    Timing of Recognition 26

    Record Keeping Systems 27

    Accounting Decisions Review-Preview 28

    User Decisions 37

    Introduction 37

    Assess Usefulness 38

    Usefulness Criteria and User Decisions 38

    The Challenge Outsiders Confront When They Assess Usefulness 39

    Risk and Divergent Beliefs Amplify the Challenge 43

    Auditor and Regulator Validations and Restrictions on Insider Accounting Judgments 44

    The Consequences of Restrictions on Usefulness 44

    Assess Performance 45

    Construct Measures 45

    Compare to Benchmarks 45

    Corroborate with Other Facts 46

    Assess Confidence 47

    Is refinement cost effective? 47

    Employ Decision Models 47

    Make Decisions 48

    Conceptual Framework Review 49

    Exercise 10.01 51

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    19912009 NavAcc LLC, G. Peter & Carolyn R. Wilson

    Chapter 10: Conceptual Framework

    INTRODUCTIONThis chapter builds on the foundation laid in the prior chapters to help you meet Navigating Accountings first goal to help you acquire a broad conceptual framework for understanding and preparing financial, managerial, and tax reports that will serve as a solid foundation for your career and other courses.

    You will need to understand the concepts presented here to critically analyze financial statements. But these concepts also apply to many other accounting and tax reports that you will likely use or create.

    To develop this groundwork, we will dissect in considerable detail the three decisions in the conceptual framework that affect and are affected by accounting reports: business decisions, accounting decisions, and user decisions. We begin in the next section with business decisions and their performance consequences. Before doing so, we will quickly review the big-picture perspective of the framework that was covered in the Preface:

    Reportingentitiesmakebusinessdecisionsthatleadtoeconomicoutcomes that affect the entities resources and obligations.

    Accountingdecisionsdeterminewhether,where,when,andhowthese events are measured and reported. The resulting accounting reports help individuals and organizations, who are often outsiders, make user decisions, meaning decisions made by users of accounting reports.

    Usersdecisionscanaffecttheirownwelfareandthewelfareofother stakeholders, including the insiders who make accounting and business decisions.

    Theanticipatedconsequencesofuserdecisionsonvariousstakeholders can cause insiders to change their business and accounting decisions.

    BusinessDecisions

    AccountingDecisions

    EconomicOutcomes

    UserDecisions

    Reporting Entity Insiders

    AccountingReports

    Consequences ofUser Decisions

    Outsider or Insider Report Users

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    19912009 NavAcc LLC, G. Peter & Carolyn R. Wilson

    Navigating Accounting

    BUSINESS DECISIONS AND PERFORMANCEiNtroduCtioNCommon sense suggests that your capacity to prepare or interpret accounting reports depends on your understanding of the events they portray. As obvious as this sounds, newcomers to accounting often struggle unduly because they try to learn accounting before they adequately grasp the related business decisions and their consequences.

    You already may have on-the-job experience with business decisions or have studied them in other courses such as marketing, strategy, operations, ethics, organizational behavior, finance, and economics. If so, then you know that business decisions can be analyzed at several levels.

    To grasp relatively simple accounting procedures, you will need only to have a big-picture comprehension of the associated events. For instance, you will often need to know only who got what, from whom, and when they got these things. This is the level of understanding you have needed thus far to grasp discussions about how events affect financial statements.

    To understand complex accounting issues, you will need a more profound understanding of the related events. In particular, you will need to understand how risks and rewards associated with numerous economic, political, legal, and social factors influence business decisions, events, and performance.

    As you progress through Navigating Accounting, you will learn a good deal about companies day-to-day business decisions and how they affect performance the primary concept that accountants try to measure reliably.

    This section prepares you for these discussions by defining performance in business settings and describing how companies organize to perform.

    what does it meaN to say that a BusiNess perForms?Business entities perform to the extent their decisions, and other factors that are beyond their control and influence, lead to outcomes that meet their objectives and priorities.

    Thus, when an entity determines its objectives and priorities, it orients other business decisions and creates a context for assessing performance. It also orients accounting decisions since they largely connect events

    BusinessDecisions

    AccountingDecisions

    EconomicOutcomes

    Insiders

    UserDecisions

    Outsiders

    AccountingReports

    Consequences ofUser Decisions

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    19912009 NavAcc LLC, G. Peter & Carolyn R. Wilson

    Chapter 10: Conceptual Framework

    to reports that indicate, albeit imperfectly, how well the entity has performed or will perform against its objectives.

    Entities generally establish objectives in terms of their stakeholders interests and designate one stakeholder group as their highest priority. Those entities whose highest priority is to maximize the value of their owners stakes are called for-profit businesses. Examples include for-profit partnerships, corporations, and sole proprietorships. Those entities whose highest priority is to maximize a broader social objective are called not-for profit organizations. Examples include charitable organizations and government agencies.

    Navigating Accounting focuses on for-profit corporations and these are businesses that seek first and foremost to maximize shareholder value. This overarching objective is a compass that orients corporate business decisions.

    perFormaNCe ChalleNgesKnowing where you are going does not guarantee that you will get there. Once an entity determines its objectives and priorities, it must create an infrastructure to try to accomplish them.

    This involves several challenging business decisions, including (among other things) determining goals, strategies, performance units, management structures, legal structures, information systems, and incentives. This section examines these business decisions and their consequences for accounting reports.

    Objectives, goals, and strategies influence the way companies organize, perform, and develop performance measures. To further facilitate performance, companies subdivide into performance units, such as credit and sales departments, and coordinate activities across these subentities.

    The significance of these issues to accounting is that large multinational corporations can have hundreds of entities that include performance measures in their accounting reports. These reports are used internally and aggregated to produce company-wide performance measures, which are reported to shareholders.

    Corporate performance goals and strategies should be consistent with maximizing shareholder value, and employees should be provided with incentives and guidance to reach them. Corporations perform to the extent they meet this management challenge by making business decisions that increase their net assets (assets - liabilities).

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    19912009 NavAcc LLC, G. Peter & Carolyn R. Wilson

    Navigating Accounting

    A sports analogy might help you appreciate the magnitude of this challenge. If you have played sports or are a fan, then you know how difficult it is to organize a small group of 5 to 50 players into a winning team.

    You also realize that coaching makes a big difference in the way players perform individually and collectively and that coaching becomes increasingly challenging as the number of players and rules increase.

    The coaching challenges at major corporations are mind-boggling when compared to sports. Corporations have thousands of players spread around the world who are running millions of plays each year and competing in tough, fast-moving leagues. There are countless rules that are changing continuously, and they are often extremely vague.

    If you agree that coaching quality makes a difference in sports, imagine the value that can be created or destroyed by the ways corporations organize