2 Financial Reporting: Its Conceptual Framework

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• 2 Financial Reporting Its Conceptual Framework

Accounting School Zhongnan University of
Economics Law
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Intermediate Accounting 2 Financial Reporting
Its Conceptual Framework
1. FASB conceptual framework

• FASB was given two charges
• To develop a conceptual framework of accounting
  theory.
• To establish standards (GAAP) for financial
  accounting practices.

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Intermediate Accounting 2 Financial Reporting
Its Conceptual Framework
Functions of FASB 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.

Continued
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Intermediate Accounting 2 Financial Reporting
Its Conceptual Framework
Functions of FASB Conceptual Framework

• To increase users understanding of and
  confidence in financial reporting.
• To enhance comparability.

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Intermediate Accounting 2 Financial Reporting
Its Conceptual Framework
Statements of Financial Accounting Concepts
issued by FASB

• Concepts Statement No. 1Objectives of Financial
  Reporting by Business Enterprises(Issue Date
  11/78)
• Concepts Statement No. 2Qualitative
  Characteristics of Accounting Information(Issue
  Date 5/80)

Continued
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Intermediate Accounting 2 Financial Reporting
Its Conceptual Framework
Statements of Financial Accounting Concepts
issued by FASB

• Concepts Statement No. 3Elements of Financial
  Statements of Business Enterprises(Issue Date
  12/80, replaced by No. 6 in 1985)
• Concepts Statement No. 4Objectives of Financial
  Reporting by Nonbusiness Organizations(Issue
  Date 12/80)

Continued
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Intermediate Accounting 2 Financial Reporting
Its Conceptual Framework
Statements of Financial Accounting Concepts
issued by FASB

• Concepts Statement No. 5Recognition and
  Measurement in Financial Statements of Business
  Enterprises(Issue Date 12/84)
• Concepts Statement No. 6Elements of Financial
  Statementsa replacement of FASB Concepts
  Statement No. 3 (incorporating an amendment of
  FASB Concepts Statement No. 2) (Issue Date
  12/85)

Continued
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Intermediate Accounting 2 Financial Reporting
Its Conceptual Framework
Statements of Financial Accounting Concepts
issued by FASB

• Concepts Statement No. 7Using Cash Flow
  Information and Present Value in Accounting
  Measurements(Issue Date 2/00)

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Intermediate Accounting 2 Financial Reporting
Its Conceptual Framework
Relationship of Conceptual Framework and
Standard-Setting Process

Conceptual Framework
Continued
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Intermediate Accounting 2 Financial Reporting
Its Conceptual Framework
Relationship of Conceptual Framework and
Standard-Setting Process

Standard Setting
Standards
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Intermediate Accounting 2 Financial Reporting
Its Conceptual Framework
Conceptual Framework Overview

Objectives of Financial Reporting
Qualitative Characteristics of Accounting Informat
ion
Elements of Financial Statements
Recognition and Measurement Concepts
Assumptions
Principles
Constraints
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Intermediate Accounting 2 Financial Reporting
Its Conceptual Framework
Objectives of Financial Reportingbroad objectives

Financial reporting should provide information
that is useful to present and potential investors
and creditors and other users in making rational
investment, credit, and similar decisions.
Usefulness
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Intermediate Accounting 2 Financial Reporting
Its Conceptual Framework
Objectives of Financial Reporting

Financial reporting should provide information
that is understandable to one who has a
reasonable knowledge of accounting and business
and who is willing to study and analyze the
information presented.
Understandability
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Intermediate Accounting 2 Financial Reporting
Its Conceptual Framework
Objectives of Financial Reporting

While there are many potential users of
financial reports, the objectives are directed
primarily toward investors and creditors.
Target Audience
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Intermediate Accounting 2 Financial Reporting
Its Conceptual Framework
Objectives of Financial Reportingspecific
objectives

Financial reporting should provide information
that is useful in assessing amounts, timing, and
uncertainty (risk) of prospective cash flows.
Assessing Future Cash Flows
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Intermediate Accounting 2 Financial Reporting
Its Conceptual Framework
Objectives of Financial Reportingspecific
objectives

Financial reporting should also provide
information about an enterprises assets,
liabilities, and owners equity to help
investors, creditors, and others evaluate the
financial strengths and weaknesses of the
enterprise and its liquidity and solvency.
Evaluating Economic Resources
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Intermediate Accounting 2 Financial Reporting
Its Conceptual Framework
Objectives of Financial Reportingspecific
objectives

Information about enterprise earnings, measured
by accrual accounting, generally provides a
better basis for forecasting future performance
than does information about current cash receipts
and disbursements.
Primary Focus on Earnings
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Intermediate Accounting 2 Financial Reporting
Its Conceptual Framework
Types of useful information

• Return on investment provides a measure of
  overall company performance.
• Risk is the uncertainty of unpredictability of
  the future results of a company.
• Financial flexibility is the ability of a company
  to take effective actions to change the amounts
  and timing of cash flows.

Continued
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Intermediate Accounting 2 Financial Reporting
Its Conceptual Framework
Types of useful information

• Liquidity is the term used to describe how
  quickly an asset can be converted into cash or a
  liability paid.
• Operating capability refers to the ability of a
  company to maintain a given physical level of
  operation.

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Intermediate Accounting 2 Financial Reporting
Its Conceptual Framework
3. Qualitative characteristics of accounting
information

FASB Statement of Financial Accounting Concepts
No. 2 specifies qualitative characteristics of
accounting information that accounting
information should possess in order to be most
useful. Different from China, FASB has set
hierarchy of qualitative characteristics.
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Hierarchy of Qualitative Characteristics
Intermediate Accounting 2 Financial Reporting
Its Conceptual Framework
Accounting Information
Pervasive Constraint
User-Specific Quality
Overall Quality
Continued
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Intermediate Accounting 2 Financial Reporting
Its Conceptual Framework
Hierarchy of Qualitative Characteristics
Relevance
Reliability
Secondary and Interactive Qualities
Threshold for Recognition
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Intermediate Accounting 2 Financial Reporting
Its Conceptual Framework
Relevance making a difference

• Predictive Value
• Helps a decision maker predict future
  consequences based on information about past
  transactions and events.
• Feedback Value
• Helps to confirm or change a decision makers
  beliefs based on whether the information matches
  what was expected.
• Timeliness
• Quality of information that is provided on a
  timely basis.

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Intermediate Accounting 2 Financial Reporting
Its Conceptual Framework
Reliability

Free from error and represents what it claims to
represent.

• Verifiability
• Reported information should be based on
  objectively determined facts that can be verified
  by other accountants using the same measurement
  methods.
• Representational Faithfulness
• The amounts and descriptions reported in the
  financial statements should reflect the actual
  results of economic transactions and events.
• Neutrality
• The information should be presented in an
  unbiased manner fairness.

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Intermediate Accounting 2 Financial Reporting
Its Conceptual Framework
Comparability

• Comparability requires that similar events be
  accounted for in the same manner on the financial
  statements of (1) different companies and (2) for
  a particular company for different periods
  (consistency).

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Intermediate Accounting 2 Financial Reporting
Its Conceptual Framework
Materiality

Is the item large enough to influence the
decision of a user of the information?
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Intermediate Accounting 2 Financial Reporting
Its Conceptual Framework
4. Accounting assumptions and conventions

Certain assumptions and conventions have
influenced the development of generally accepted
accounting principles. These are similar with
those of China.
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Intermediate Accounting 2 Financial Reporting
Its Conceptual Framework
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.
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Intermediate Accounting 2 Financial Reporting
Its Conceptual Framework
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.
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Intermediate Accounting 2 Financial Reporting
Its Conceptual Framework
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.
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Intermediate Accounting 2 Financial Reporting
Its Conceptual Framework
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.
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Intermediate Accounting 2 Financial Reporting
Its Conceptual Framework
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.
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Intermediate Accounting 2 Financial Reporting
Its Conceptual Framework
Realization and Recognition

Realization is the process of converting noncash
resources and rights into cash or rights to cash.
Recognition is the process of formally recording
and reporting an item in the financial statements
of a company.
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Intermediate Accounting 2 Financial Reporting
Its Conceptual Framework
Matching and Accrual Accounting

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.
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Intermediate Accounting 2 Financial Reporting
Its Conceptual Framework
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.
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Intermediate Accounting 2 Financial Reporting
Its Conceptual Framework
5. Elements of financial statements

• Main financial statements
• Balance Sheet
• Income statement
• Statement of Cash Flows
• Statement of Changes in Equity

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Intermediate Accounting 2 Financial Reporting
Its Conceptual Framework
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.

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Intermediate Accounting 2 Financial Reporting
Its Conceptual Framework
Elements of Income Statement

• 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
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Intermediate Accounting 2 Financial Reporting
Its Conceptual Framework
Elements of Income Statement

• Expenses are outflows or other using up of assets
  of a company or incurrence 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
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Intermediate Accounting 2 Financial Reporting
Its Conceptual Framework
Elements of Income Statement

• 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
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Intermediate Accounting 2 Financial Reporting
Its Conceptual Framework
Elements of Income Statement

• 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.

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Intermediate Accounting 2 Financial Reporting
Its Conceptual Framework
Elements of Statement of Cash Flows

• Operating cash flows are the flows of cash from
  acquiring, selling, and delivering goods for
  sale, as well as providing services.
• Investing cash flows are the flows of cash from
  acquiring and selling investments, property,
  plant, and equipment, as well as from lending
  money and collecting on loans.
• Financing cash flows are the flows of cash to and
  from the owners and long-term creditors.

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Intermediate Accounting 2 Financial Reporting
Its Conceptual Framework
Elements of Statement of Changes in Equity

• 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.

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Intermediate Accounting 2 Financial Reporting
Its Conceptual Framework
6. Comparison of accounting concepts in China and
in U.S.

Could you compare accounting concepts in China
and in U.S.?
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The End