Chapter 2

The Pursuit of the Conceptual Framework

Introduction

What is the conceptual framework?

The Early TheoristsPaton and Canning

DR Scott and his conceptual framework

Early Authoritative and Semi-authoritative Organizational Attempts to Develop the Conceptual Framework of Accounting

A Tentative Statement of Accounting Principles Affecting Corporate Reports

A Statement

of Accounting Principles

An Introduction to Corporate Accounting Standards ARSs

No. 1 and No. 3

APB Statement

No. 4ASOBAT

The Trueblood Committee

Committee report specified the following four information needs of users:

1. Making decisions concerning the use of limited resources

2. Effectively directing and controlling organizations3. Maintaining and reporting on the custodianship of

resources4. Facilitating social functions and controls

Objectives of financial reporting

Statement on Accounting Theory and Theory Acceptance

Rationale for the committee’s approach

The approaches to accounting theory were condensed into

1. Classical

2. Decision Usefulness

3. Information Economics.

Criticisms of the approaches to theory

The FASB’s Conceptual Framework Project

The objectives identify the goals and purposes of financial accounting; whereas, the fundamentals are the underlying concepts that help achieve those objectives. These concepts are designed to provide guidance in:1. Selecting the transactions, events and circumstances to be

accounted for2. Determining how the selected transactions, events, and

transactions should be measured3. Determining how to summarize and report the results of

events, transactions and circumstances.

SFAC No. 1 “Objectives of Financial Reporting By Business Enterprises”

1. Assess cash flow prospects

2. Report on enterprise resources, claims against resources and changes in them

3. Report economic resources, obligations and owners equity

4. Report enterprise performance and earnings

5. Evaluate liquidity, solvency, and flow of funds

6. Evaluate management stewardship and performance

7. Explain and interpret financial information

No. 2 “Qualitative Characteristics of Accounting Information

Addresses the question: What makes accounting information useful?

Develops a Hierarchy of Accounting Qualities

Decision makers and their characteristics

(for example, understanding of prior knowledge)

A Hierarchy of Accounting Qualities

Users of Accounting Information

Pervasive Constraint

User-specific qualities

Primary Decision-specificqualities

Ingredients of primary qualities

Threshold for recognition

Understandability

Decision Usefulness

Feedback value

Benefits > Costs

Relevance Reliability

RepresentationalFaithfulness

VerifiabilityTimeliness

Neutrality

Comparability and Consistency

Materiality

Predictive value

No. 5 “Recognition and Measurement in Financial Statements of Business Enterprises”

Sets forth recognition criteria and guidance on what information should be incorporated into financial statements and when this information should be reportedDefined comprehensive income as:

Revenues EarningsLess: Expenses Plus or minus cumulative

accounting adjustmentsPlus: Gains Plus or minus other

non-owner changes in equityLess: Losses= Earnings = Comprehensive Income

No. 5 “Recognition and Measurement in Financial Statements of Business Enterprises”

Measurement Issues1. Definitions.

The item meets the definition of an element contained in SFAC No. 6.

2. Measurability. It has a relevant attribute measurable with sufficient reliability.

3. Relevance. The information about the item is capable of making a

difference in user decisions.

4. Reliability. The information is representationally faithful, verifiable, and

neutral.

No. 6 “The Elements of Financial Statements”

Defines the ten elements of financial statements that are used to measure the performance and position of economic entities

These elements are discussed in more depth in Chapters 6 and 7.

How should present value amortizations be used when the estimates of cash flows change?

How should the estimates of cash flows and interest rates be developed?

Does the measurement of liabilities at present value differ from the measurement of assets?

SFAC No. 7 “Using Cash Flow Information and Present Value in Accounting Measurements”

Accounting measurement is a very broad topic. Consequently, the FASB focused on a series of questions relevant to measurement and amortization conventions that employ present value techniques. Among these questions are:

What are the objectives of using present value in the initial recognition of assets and liabilities? And, do these objectives differ in subsequent fresh-start measurements of assets and liabilities?

What are the objectives of present value when used in conjunction with the amortization of assets and liabilities?

Present value measurements that fully captures the economic differences between assets should

include the following elements:

SFAC No. 7 “Using Cash Flow Information and Present Value in Accounting Measurements”

1. An estimate of the future cash flows

2. Expectations about variations in the timing of those cash flows

3. The time value of money represented by the risk-free rate of interest

4. The price for bearing the uncertainty

5. Other, sometimes unidentifiable, factors including illiquidity and market imperfections

Approaches to present value1. Traditional2. Expected cash flow

SFAC No. 7 “Using Cash Flow Information and Present Value in Accounting Measurements”

Incorporating probabilitiesThe objective is to estimate the value of the assets required currently to settle the liability with the holder or transfer the liability to an entity with a comparable credit standing

Use of the interest method

Principles Based vs. Rules Based Accounting Standards

Continuum ranging from highly rigid standards on one end

to general definitions of economics-based concepts on the other end.

Previous practice: Goodwill is to be amortized over a 40 life until it is fully amortized.

Example: Goodwill

New FASB rule:Goodwill is not amortized. Any recorded goodwill is to be tested for impairment and written down to its current fair value on an annual basis.

FASB Questions

1. Do you support the Board’s proposal for a principles-based approach to U. S. standard setting?

Will that approach improve the quality and transparency of U. S. financial accounting and reporting?

2. Should the Board develop an overall reporting framework as in IAS 1?If so, should that framework include a true and fair override?

3. Under what circumstances should interpretive and implementation guidance be provided under a principles-based approach to U.S. standard setting?

Should the Board be the primary standard setter responsible for providing that guidance?

4. Will preparers, auditors, the SEC, investors, creditors, and other users of financial information be able to adjust to a principles-based approach to U.S. standard setting?

If not, what needs to be done and by whom?5. What other factors should the Board consider in assessing the extent to

which it should adopt a principles-based approach to U.S. standard setting?6. What are the benefits and costs (including transition costs) of adopting a

principles-based approach to U.S. standard setting? How might those benefits and costs be quantified?

Principles Based vs. Rules Based Accounting Standards

The AAA’s position

Dissenting opinion

Copyright © 2005 John Wiley & Sons, Inc.  All rights reserved.Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the

express written consent of the copyright owner is unlawful.  Request for further information should be addressed to the Permissions

Department, John Wiley & Sons, Inc.  The purchaser may make back-up copies for his/her own use only and not for distribution or resale. 

The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the

information contained herein.

Prepared by Kathryn Yarbrough, MBA