1. Chapter 2: The Conceptual Framework Fundamentals of
Intermediate Accounting Weygandt, Kieso, and Warfield Prepared by
Bonnie Harrison, College of Southern Maryland LaPlata,
Maryland
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
Statement 1
Statement 2
Statement 6
Statement 4
Statement 5
Statement 7
Objectives of Financial Reporting (Business)
Qualitative Characteristics
Elements of Financial Statements ( replaces 3 )
Objectives of Financial Reporting (Nonbusiness)
Recognition and Measurement Criteria
Using Cash Flows
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
To provide information :
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 :
* verifiable
* representationally faithful, and
* neutral
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
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
Going Concern Assumption
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
Monetary Unit
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.
Disclosure may be made:
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
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
rights reserved. Reproduction or translation of this work beyond
that named 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.
