2 The Conceptual Framework
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- 1. Chapter 2: The Conceptual Framework Fundamentals of
Intermediate Accounting Weygandt, Kieso, and Warfield Prepared by
Bonnie Harrison, College of Southern Maryland LaPlata,
Maryland
- 2. Chapter 2 Conceptual Framework Underlying Financial
Accounting
- Describe the usefulness of a conceptual framework.
- Describe the FASBs efforts to construct a conceptual
framework.
- Understand the objectives of financial reporting.
- Identify the qualitative characteristics of accounting
information.
- Define the basic elements of financial statements.
1 After studying this chapter, you should be able to: 2 3 4 5
- 3. Chapter 2 Conceptual Framework Underlying Financial
Accounting
- Describe the basic assumptions of accounting.
- Explain the applications of the basic principles of
accounting.
- Describe the impact that constraints have on reporting
accounting information.
After studying the chapter, you should be able to: 6 8 7
- 4. Introduction
- Users of financial statements need relevant and reliable
information.
- To provide such information, the profession has developed a set
of principles and guidelines .
- These principles and guidelines are collectively called the
Conceptual Framework.
- In short, the Framework is like a constitution for the
profession.
- 5. Objectives of the Conceptual Framework
- The Framework is 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.
- 6. Statements of Financial Accounting Concepts
- The FASB has issued seven Statements of Financial Accounting
Concepts (SFACs) to date .
- These statements set forth major recognition and reporting
issues.
- Statement 4 pertains to reporting by nonbusiness entities.
- The other six statements pertain to reporting by business
enterprises.
- 7. Statements of Financial Accounting Concepts
- Objectives of Financial Reporting (Business)
- Qualitative Characteristics
- Elements of Financial Statements ( replaces 3 )
- Objectives of Financial Reporting (Nonbusiness)
- Recognition and Measurement Criteria
Brief Title Statement
- 8. Overview of the Conceptual Framework (1 of 2)
- The Framework has three levels: objectives, elements and
criteria.
- The first level consists of objectives .
- The second level explains financial statement elements and
characteristics of information
- The third level incorporates recognition and measurement
criteria .
- 9. Overview of the Conceptual Framework (2 of 2) Level 3 :
Recognition and Measurement Concepts Level 2 : Elements of
Financial Statements and Qualitative Characteristics of Accounting
Information Level 1 : Objectives of Financial Reporting Objectives
Qual Charac . Elements Implemen - tation
- 10. Basic Objectives of Financial Reporting
- that is u seful to those making investment and credit decisions
who reasonably understand business and
- that is useful to present and future investors, creditors in
assessing future cash flows
- about economic resources , the claims on those resources and
changes in them
- 11. Qualitative Characteristics of Accounting Information
- Primary qualities are relevance and reliability of accounting
information.
- Secondary qualities are comparability and consistency of
reported information.
- 12.
- Relevance of information means information capable of making a
difference in a decision context. To be relevant:
- The information must be timely .
- The information should have predictive value : (be helpful in
making predictions about ultimate outcomes of past, present and
future events).
- The information should have feedback value (helps users to
confirm prior expectations .)
Qualitative Characteristics of Accounting Information:
Relevance
- 13.
- Information is reliable , when it can be relied on to represent
the true, underlying situation.
- To be reliable, information must be :
- * representationally faithful, and
Primary Characteristic: Reliability
- 14.
- Information is verifiable , when, given the same information,
independent users can arrive at similar conclusions.
- Information is faithful , when it represents what really
existed or happened.
- Information is neutral , when it is free from bias.
Primary Characteristic: Reliability
- 15. Secondary Characteristics
- Secondary characteristics are: comparability and consistency of
reported information.
- For information to be c omparable, it must be :
- measured and reported in a similar manner for different
enterprises.
- useful in the allocation of resources to the areas of greatest
benefit.
- useful to users in identifying real differences between
enterprises.
- 16. Secondary Characteristics
- Accounting information is consistent, if the same accounting
principles are applied in a similar manner from one period to the
next.
- Accounting principles may be changed, if the change results in
better reporting.
- If principles are changed, the justification for, and the
nature and effect of the change, must be disclosed.
- 17. Hierarchy of Accounting Qualities Decision Makers What are
their characteristics? Constraints Cost benefit & Materiality
User specific Qualities Understandability Pervasive Criterion
Decision Usefulness Primary Qualities Relevance & Reliability
Secondary Qualities Comparability & Consistency
- 18. Ingredients of Primary Qualities Relevance Reliability
Predictive Value Feedback Value Timeliness Verifiability Represent.
Faithfulness Neutrality
- 19. Basic Elements of Financial Statements
- Assets : Probable future economic benefits resulting from past
transactions
- Liabilities : Probable future sacrifices of economic benefits
resulting from past transactions
- Equity : Residual or ownership interest
- Investment by Owners : Increases in net assets
- Distributions to Owners : Decreases in net assets
- Comprehensive Income: All changes in equity from non-owner
sources
- Revenues : Inflows from entitys ongoing operations
- Expenses : Outflows from entitys ongoing operations
- Gains : Increases in equity from incidental transactions
- Losses : Decreases in equity from incidental transactions
Balance Sheet Income Statement
- 20. Recognition and Measurement Criteria Basic Assumptions
Principles
Constraints 1. Cost Benefit 2. Materiality 3. Industry practices 4.
Conservatism
- 21. Basic Assumptions
- 22. Basic Assumptions
- Economic Entity Assumption
-
- The economic entity can be identified with a particular unit of
accountability.
-
- The business is separate and distinct from its owners.
-
- Entitys assets and other financial elements are not commingled
with those of the owners.
-
- The economic entity assumption is an accounting concept, and
not a legal construct.
- 23. Basic Assumptions
-
- The business is assumed to continue indefinitely unless
terminated by owners.
-
- The basis of recording financial elements is historical
accounting .
-
- Liquidation accounting (based on liquidation values) is not
followed unless so indicated.
- 24. Basic Assumptions
-
- Money is the common unit of measure of economic
transactions.
-
- Use of a monetary unit is relevant, simple to understand and
universally available.
-
- Price level changes are ignored in accounting, leading to the
assumption that the dollar remains relatively stable .
- 25. Basic Assumptions
- Periodicity (Time Period) Assumption
-
- Economic activity of an entity may be artificially divided into
time periods for reporting purposes.
-
- Shorter time periods are subject to revisions but may be more
timely.
- 26. Basic Principles
- 27. The Cost Principle
- Historical Cost Principle
-
- Transaction is recorded at its acquisition price .
-
- It is not changed to reflect market price.
-
- The principle applies to most assets and liabilities.
-
- Users of financial statements may find fair value information
useful for certain types of assets and liabilities.
-
- The current system is a mixed attribute incorporating
historical cost, fair value, and certain other valuation
bases.
22 22
- 28. The Revenue Recognition Principle
- Revenue Recognition Principle
-
- Revenue is recognized when it is realized or realizable and
earned and the amount can be objectively determined.
-
- Revenue is recognized at time of sale . There are exceptions
:
-
-
- During production: In long-term construction revenue is
recognized periodically based on % of job completed.
-
-
- End of production: Where active markets exist for the product
and there are no significant future costs..
-
-
- Receipt of cash: Used when there is uncertainty of collection.
In installment sales contracts payment is required in periodic
installments.
- 29. The Matching Principle
- Expenses are matched to the revenues they help generate.
- There should be a logical, rational association of revenues and
expenses.
- If a cost does not benefit future periods, it is recorded in
the current period as an expense.
24 24
- 30. The Full Disclosure Principle
- Financial statements must report what a reasonable person would
need to know to make an informed decision.
-
- within the body of the financial statements,
-
- as notes to those statements, or
-
- as supplementary information.
- 31. Constraints
- 32. Constraints: The Cost Benefit Rule
- Cost-Benefit Relationship
-
- The cost of providing information should not outweigh the
benefit derived.
-
- Costs and benefits are not always obvious or measurable.
-
- Sound judgment must be used in providing information .
- 33.
- Materiality refers to an items importance to a firms overall
financial operations.
-
- An item must make a difference to be material and be
disclosed.
-
- It is a matter of the relative significance of the
element.
-
- Both quantitative and qualitative factors are to be considered
in determining relative significance.
Constraints: Materiality
- 34. Constraints: Industry Practices
-
- The nature of some industries sometimes require departures from
basic accounting theory.
-
- If application of accounting theory results in statements that
are not comparable or consistent, then industry practices must be
examined for possible explanations.
- 35. Constraints: Conservatism
- Conservatism suggests that the preparer, when in doubt, choose
a conservative solution .
- This solution will be least likely to overstate assets and
income.
- Conservatism does not suggest that net assets or net income be
deliberately understated.
- 36. COPYRIGHT Copyright 2003 John Wiley & Sons, Inc. All
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