Conceptual Framework Underlying Financial Accounting

1

• Chapter 1

Conceptual Framework Underlying Financial
Accounting
2
Learning Objectives

1. Explain the FASB conceptual framework.
2. Understand the relationship among the objectives
   of financial reporting.
3. Identify the general objective of financial
   reporting.
4. Describe the three specific objectives of
   financial reporting.

Continued
3
Learning Objectives

1. Discuss the types of useful information for
   investment and credit decision making.
2. Explain the qualities of useful accounting
   information.
3. Understand the accounting assumptions and
   conventions that influence GAAP.
4. Define the elements of financial statements.

4
The FASBs Conceptual Framework

• How do we determine the amount of
  information to
• supply in general-purpose financial
  statements?
• In what format?
• Under what assumptions, principles, and
• constraints?

5
The FASBs Conceptual Framework

• To guide the FASB in establishing accounting
  standards.
• To provide a frame of reference for resolving
  accounting questions in situations where a
  standard does not exist.
• To determine the bounds for judgment in the
  preparation of financial statements.
• To increase users understanding of and
  confidence in financial reporting.
• To enhance comparability.

6
The FASBs Conceptual Framework

• The FASBa role is to . . .
• Establish consensus on topical accounting issues.
• Interpret accounting principles.
• Keep accounting practice as standardized as
  possible.

7
The FASBs Conceptual Framework

• Accounting standards should be consistent with
  the framework.
• New problems can be effectively resolved with
  reference to the framework.
• User can benefit from a more comprehensive
  understanding of the accounting information in
  financial statements.

8
Charges Given to the FASB
To develop a conceptual framework of accounting
theory.
9
Charges Given to the FASB
To establish standards (GAAP) for financial
accounting practices.
10
Relationship of Conceptual Framework and
Standard-Setting Process
11
Conceptual Framework Projects for Financial
Accounting and Reporting
12
Objectives of Financial Reporting
General Objective Provide information that is
useful to present and potential investors,
creditors, and other users in making rational
investment, credit, and similar decisions.
13
SFAC No. 1

• Objectives of Financial Reporting by Business
  Enterprises
• Target audience . . .
• External users of financial information
• Have a reasonable understanding of business and
  economic activities and are willing to study the
  information

14
SFAC No. 1Financial Reporting Objectives

• Provide information that . . .
• Is useful in making rational investment, credit
  and other related decisions.
• Helps assess the amount, timing and uncertainty
  of future cash flows.
• Is accurate in reporting the economic resources
  of the business.
• Provide information about a companys
  comprehensive income and its components.

15
Interrelationship of Final Reports, Useful
Information and Decision Making
Types of Useful Information
Communication Documents
External Decision Making
Financial Reports
16
Hierarchy of Qualitative Characteristics
Accounting Information
Pervasive Constraint
User-Specific Quality
Overall Quality
Continued
17
Hierarchy of Qualitative Characteristics
Relevance
Reliability
Secondary and Interactive Qualities
Threshold for Recognition
18
SFAC No. 2
Accounting information is relevant if it can make
a difference in a decision.
19
SFAC No. 2

• Qualitative Characteristics of Accounting
  Information
• Primary Quality . . . Relevance.
• 1. Timeliness
• 2. Predictive value
• 3. Feedback value

20
SFAC No. 2
Accounting information is reliable when it is
reasonably free from error and bias, and
faithfully represents what it is intended to
represent.
21
SFAC No. 2

• Qualitative Characteristics of Accounting
  Information
• Primary Quality . . . Reliability.
• 1. Representational faithfulness
• 2. Verifiability
• 3. Neutrality

22
SFAC No. 2

• Qualitative Characteristics of Accounting
  Information
• Secondary Qualities
• Comparability and Consistency

23
SFAC No. 3
Comparability of accounting information enables
users to identify and explain similarities and
differences between two or more sets of economic
facts.
24
SFAC No. 3

• Recognition and Measurement in Financial
  Statements of Business Enterprises
• 1. Recognition criteria
• 2. Measurement criteria
• 3. Environmental assumptions
• 4. Implementation principles
• 5. Implementation constraints
• 6. General-purpose financial statements

25
SFAC No. 3
Recognition is the process of formally recording
and reporting an item in the financial statements
of a company.
26
SFAC No. 3Recognition Criteria

• Definition
• Measurability
• Relevance
• Reliability

27
SFAC No. 4Measurement Criteria

• Continued use of different attributes (historical
  cost, current cost, market value, etc.).
• All monetary measurement based on nominal units
  of money.

28
SFAC No. 4Environmental Assumptions

• Separate entity assumption
• Continuity assumption
• Unit-of-measure assumption
• Time period assumption

29
SFAC No. 4Environmental Assumptions
Entity
The entity assumption assumes that a
proprietorship, partnership, or corporations
financial activities are distinguished from other
financial organizations in keeping its own
financial records and reports.
30
SFAC No. 4Environmental Assumptions
Continuity
This assumption assumes that the company will
continue to operate in the near future, unless
substantial evidence to the contrary exists.
This assumption is also known as the
going-concern assumption.
31
SFAC No. 4Environmental Assumptions
Period of Time
In accordance with the period-of-time assumption,
a company prepares financial statements at the
end of each year and includes them its annual
report. The period-of-time assumption is the
basis for the adjusting entry process at
period-end.
32
SFAC No. 4Environmental Assumptions
Monetary Unit
This assumption states that there must be some
basis for measuring exchange of goods or
services. Currently the dollar is considered to
be a stable monetary unit for preparing a
companys financial statements.
The FASB encourages companies to prepare
supplemental disclosures about the impact of
changing prices.
33
SFAC No. 4Implementation Principles

• Cost principle
• Realization principle
• Matching concept
• Full disclosure principle

34
SFAC No. 4Implementation Principles
Historical Cost
Usually, the exchange price is retained in the
accounting records as the value of an item until
it is removed from the records.
35
SFAC No.4Implementation Principles
Historical Cost
Which amount should be used?
36
SFAC No. 5Implementation Principles
Realization is the process of converting noncash
resources and rights into cash or rights to cash.

37
SFAC No. 5Implementation Principles
Realization principle Two conditions must be met
if therevenue principle is to be satisfied.
Reasonable Assurance of Collection
Substantial Completion of Earning Process
38
SFAC No. 5Implementation Principles
Matching Pinciple
Accrual accounting is the process of relating the
financial effects of transactions, events, and
circumstances having cash consequences to the
period in which they occur rather than to when
the cash receipt or payment occurs.
39
SFAC No. 5Implementation Principles
Matching Principle
Accrual accounting is the process of relating the
financial effects of transactions, events, and
circumstances having cash consequences to the
period in which they occur rather than to when
the cash receipt or payment occurs.
The matching principle states that to determine
the income of a company for an accounting period,
the company computes the total expense involved
in obtaining the revenues of the period and
relates these total expenses to the total
revenues recorded in the period.
40
SFAC No. 5Implementation Principles
Full Disclosure Principle

• Parenthetical Comments
• Disclosure Notes
• Supplemental Financial Statements

41
SFAC No. 5Implementation Constraints

• Cost-benefit constraint
• Materiality constraint
• Conservatism constraint
• Industrial peculiarities

42
SFAC No. 5Implementation Constraints
Cost-benefit Constraint
Are benefits greater than costs?
43
SFAC No. 5Implementation Constraints
Materiality

• The nature of the item.
• The relative size rather than absolute size of an
  item.

44
SFAC No. 5Implementation Constraints
Conservatism
The conservatism convention states that when
alternative accounting valuations are equally
possible, the accountant should select the one
that is least likely to overstate assets and
income in the current period.
45
General-Purpose Financial Statements

• 1. Statement of Financial Position (Balance
  Sheet)
• 2. Earnings (Income Statement)
• 3. Cash Flows (Statement of Cash Flows)
• 4. Investment by and Distributions to Owners
  (Statement of Changes in Equity)

46
SFAC No. 6

• Elements of Financial Statements of Business
  Enterprises
• Defines 10 elements of financial statements
• Revenues, Expenses, Gains, Losses, Assets,
  Liabilities, Equity, Investment by owners,
  Distributions to owners and Comprehensive income.

All 10
47
Balance Sheet
A balance sheet is a financial statement that
summarizes the financial position of a company on
a particular date.
It also is called a statement of financial
position.
48
Balance Sheet
Elements of a balance sheet

• Assets are the probable future economic benefits
  obtained and controlled by a company as a result
  of past transactions or events.
• Liabilities are the probable future sacrifices of
  economic benefits arising from present
  obligations of a company to transfer assets or
  provide services in the future as a result of
  past transactions or events.
• Equity is the owners residual interest in the
  net assets of a company.

49
Income Statement
An income statement is a financial statement that
summarizes the results of a companys operations.
50
Income Statement
The elements of the income statement are

• Revenues are inflows or other enhancements of
  assets of a company or settlement of its
  liabilities during a period from delivering or
  producing goods, rendering services, or other
  activities that are the companys ongoing major
  operation. Revenues increase the equity of a
  company.

Continued
51
Income Statement
The elements of the income statement are

• Expenses are outflows or other using up of assets
  of a company or incurrences of liabilities during
  a period from delivering or producing goods,
  rendering services, or carrying out other
  activities that are the companys ongoing major
  operation. Expenses decrease the equity of a
  company.

Continued
52
Income Statement
The elements of the income statement are

• Gains are increases in the equity of a company
  from peripheral or incidental transactions and
  from all other transactions and other events and
  circumstances affecting the company, except those
  that result from revenues or investments by
  owners. Gains increase the equity of a company.

Continued
53
Income Statement
The elements of the income statement are

• Losses are decreases in the equity of a company,
  from peripheral or incidental transactions except
  those that result from expenses or distribution
  to owners. Losses decrease the equity of a
  company.

54
Income Statement
55
Statement of Changes in Equity
A statement of changes in equity summarizes the
changes in a companys equity for a period.
56
Statement of Changes in Equity
A statement of changes in equity contains two
elements

• Investments by owners are increases in equity
  resulting from transfers of something valuable to
  the company from other entities in order to
  obtain or increase ownership interest.
• Distribution to owners are decreases in equity of
  a company caused by transferring assets,
  rendering services, or incurring liabilities to
  owners.

57
Comprehensive Income
Comprehensive income includes all changes in
equity during a period except those resulting
form investments by owners and distributions to
owners.
58
Model of Business Reporting
Framework of the Model

1. Financial and nonfinancial data.
2. Managements analysis of the financial and
   nonfinancial data.
3. Forward-looking information.
4. Information about management and shareholders.
5. Background about the company.

59
C
1
hapter
The End
Task Force Image Gallery clip art included in
this electronic presentation is used with the
permission of NVTech Inc.