Chapter 2: The Conceptual Framework

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Chapter 2 The Conceptual Framework
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Objectives of the Conceptual 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.

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Statements of Financial Accounting Concepts

• 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.

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Statements of Financial Accounting Concepts
Brief Title
Statement

• 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

Presents the goals and purposes of accounting.
Examines the characteristics that make accounting
information useful.
Examines the characteristics that make accounting
info useful and expands 3 to include
not-for-profit orgs.
Guidelines for not-for-profit and governmental
entities.
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
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Overview of the Conceptual Framework

• The Framework has three different
  levels,comprised of

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Conceptual Framework for Financial Reporting
Chapter 2
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
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Conceptual Framework for Financial Reporting
What are these qualitative characteristics?
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Qualitative Characteristics of Accounting
Information

• Primary qualities of accounting information are
  relevance and reliability.
• Secondary qualities are comparability and
  consistency of reported information.

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Primary Characteristic of Accounting Information
Relevance

• Relevance of information means information
  capable 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

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Primary Characteristic of Accounting Information
Relevance

• 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)

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Secondary Characteristics of Accounting
Information

• 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.

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Conceptual Framework for Financial Reporting
What are these Elements?
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Basic Elements of Financial Statements

• Assets
• Liabilities
• Equity
• Investment by Owners
• Distributions to Owners

• Comprehensive Income
• Revenues
• Expenses
• Gains
• Losses

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Conceptual Framework for Financial Reporting
What are these Recognition Measurement Issues?
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Recognition and Measurement Criteria
Basic Assumptions
Principles
Constraints
1. Historical cost 2. Revenue
recognition 3. Matching 4. Full disclosure
1. Cost benefit 2. Materiality 3. Industry
practices 4. Conservatism
1. Economic entity 2. Going concern
3. Monetary unit 4. Periodicity
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Assumptions

• Economic Entity

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

• Going Concern Assumption

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.

• Monetary Unit Assumption

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

• Periodicity Assumption

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.
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Principals

• Historical Cost Principle

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

• Revenue Recognition Principle

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

• Matching Principle

Allocates expenses to revenues in the proper
period

• Full Disclosure Principle

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.
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Constraints

• Cost-Benefit Relationship

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.

• Materiality

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.

• Industry Practices

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.

• Conservatism

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.
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Summary
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
Elements Assets, Liabilities, Equity
Investment/Distribution by owners
Comprehensive Income Revenues, Expenses Gains,
Losses
Qualitative Characteristics Primary Relevance
and Reliability Secondary Comparability and
Consistency
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