CH 02 Conceptual Framework

8/11/2019 CH 02 Conceptual Framework

1/39

Chapter2-1

Conceptual Framework

Underlying Financial Accounting

Chapter2

Intermediate Accounting12th Edition

Kieso, Weygandt, and Warfield

Prepared by Coby Harmon, University of California, Santa Barbara


2/39

Chapter2-2

1. Describe the usefulness of a conceptual framework.2. Describe the FASBs efforts to construct a conceptual

framework.

3. Understand the objectives of financial reporting.

4. Identify the qualitative characteristics of accountinginformation.

5. Define the basic elements of financial statements.

6. Describe the basic assumptions of accounting.

7. Explain the application of the basic principles ofaccounting.

8. Describe the impact that constraints have on reportingaccounting information.

Chapter 2 Learning Objectives


3/39

Chapter2-3

Conceptual

Framework

Need

Development

First Level:

Basic

Objectives

Second Level:

Fundamental

Concepts

Third Level:

Recognition and

Measurement

Basic

assumptions

Basic principles

Constraints

Qualitative

characteristics

Basic elements



4/39

Chapter2-4

The Need for a Conceptual Framework

To develop a coherent set of standards and rules

To solve new and emerging practical problems


LO 1 Describe the usefulness of a conceptual framework.


5/39

Chapter2-5

Review:

A conceptual framework underlying financialaccounting is important because it can lead to

consistent standards and it prescribes thenature, function, and limits of financialaccounting and financial statements.



True


6/39

Chapter2-6

Review:

A conceptual framework underlying financialaccounting is necessary because future

accounting practice problems can be solved byreference to the conceptual framework and aformal standard-setting body will not benecessary.



False


7/39

Chapter2-7 Objective 2

The FASB has issued six Statements of FinancialAccounting Concepts(SFAC) for business enterprises.

Development of Conceptual Framework

SFAC No.1- Objectives of Financial Reporting

SFAC No.2- Qualitative Characteristics of Accounting InformationSFAC No.3- Elements of Financial Statements (superceded by

SFAC No. 6)

SFAC No.4- Nonbusiness Organizations

SFAC No.5- Recognition and Measurement in Financial StatementsSFAC No.6- Elements of Financial Statements (replaces SFAC No. 3)

SFAC No.7- Using Cash Flow Information and Present Value inAccounting Measurements

LO 2 Describe the FASBs efforts to construct a conceptual framework.


8/39

Chapter2-8

The Framework is comprised of three levels:

First Level= Basic Objectives

Second Level= Qualitative Characteristics andBasic Elements

Third Level= Recognition and MeasurementConcepts.




9/39

Chapter2-9

ASSUMPTIONS

1. Economic entity

2. Going concern

3. Monetary unit

4. Periodicity

PRINCIPLES

1. Historical cost

2. Revenue recognition

3. Matching

4. Full disclosure

CONSTRAINTS

1. Cost-benefit

2. Materiality

3. Industry practice

4. Conservatism

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

ELEMENTS

Assets, Liabilities, and Equity

Investments by owners

Distribution to owners

Comprehensive income

Revenues and Expenses

Gains and Losses

Illustration 2-6Conceptual

Framework forFinancialReporting First level

Second level

Third

level

LO 2 Describe the FASBs

efforts to construct aconceptual framework.

QUALITATIVE

CHARACTERISTICS

Relevance

Reliability

Comparability

Consistency


10/39

Chapter2-10

What are the Statements of Financial AccountingConcepts intended to establish?

a. Generally accepted accounting principles in

financial reporting by business enterprises.b. The meaning of Present fairly in accordance with

generally accepted accounting principles.

c. The objectives and concepts for use in developingstandards of financial accounting and reporting.

d. The hierarchy of sources of generally acceptedaccounting principles.



Review:

(CPA adapted)


11/39

Chapter2-11

Financial reporting should provide information that:(a) is useful to present and potential investors and creditors

and other users in making rational investment, credit, andsimilar decisions.

(b) helps present and potential investors and creditors andother users in assessing the amounts, timing, anduncertainty of prospective cash receipts.

(c) portrays the economic resources of an enterprise, theclaims to those resources, and the effects oftransactions, events, and circumstances that change itsresources and claims to those resources.

First Level: Basic Objectives

LO 3 Understand the objectives of financial reporting.


12/39

Chapter2-12

According to the FASB conceptual framework, theobjectives of financial reporting for businessenterprises are based on?

a. Generally accepted accounting principles

b. Reporting on managements stewardship.

c. The need for conservatism.

d. The needs of the users of the information.


LO 3 Understand the objectives of financial reporting.

(CPA adapted)

Review:


13/39

Chapter2-13

Question:How does a company choose an acceptable accountingmethod, the amount and types of information to

disclose, and the format in which to present it?

Second Level: Fundamental Concepts

LO 4 Identify the qualitative characteristics of accounting information.

Answer:

By determining which alternative provides the most

useful information for decision-making purposes(decision usefulness).


14/39

Chapter2-14

Qualitative Characteristics

The FASB identified the Qualitative Characteristicsof accounting information that distinguish better

(more useful) information from inferior (less useful)information for decision-making purposes.




15/39

Chapter2-15

Second Level: Qualitative Characteristics


Illustration 2-2Hierarchy of

AccountingQualities


16/39

Chapter2-16

Understandability

A company may present highly relevant and reliableinformation, however it was useless to those who do

not understand it.




17/39

Chapter2-17

ASSUMPTIONS

1. Economic entity

2. Going concern

3. Monetary unit

4. Periodicity

PRINCIPLES

1. Historical cost


3. Matching

4. Full disclosure

CONSTRAINTS

1. Cost-benefit

2. Materiality


4. Conservatism

OBJECTIVES




future cash flows

3. About enterprise


resources, and

changes in them

QUALITATIVE

CHARACTERISTICS

Relevance

Reliability

Comparability

Consistency

ELEMENTS



Distribution to ownersComprehensive income


Gains and Losses

Illustration 2-6ConceptualFramework forFinancialReporting First level

Second level

Third

levelRelevance and Reliability

LO 4 Identify the qualitative

characteristics ofaccounting information.


18/39

Chapter2-18 LO 4 Identify the qualitative characteristics of accounting information.


Primary Qualities:Relevancemaking a difference in a decision.

Predictive value

Feedback valueTimeliness

Reliability

Verifiable

Representational faithfulness

Neutral - free of error and bias


19/39

Chapter2-19

Review:


Relevance and reliability are the two primaryqualities that make accounting information usefulfor decision making.

To be reliable, accounting information must be

capable of making a difference in a decision.

True

False



20/39

Chapter2-20

ASSUMPTIONS

1. Economic entity

2. Going concern

3. Monetary unit

4. Periodicity

PRINCIPLES

1. Historical cost


3. Matching

4. Full disclosure

CONSTRAINTS

1. Cost-benefit

2. Materiality


4. Conservatism

OBJECTIVES




future cash flows

3. About enterprise


resources, and

changes in them

QUALITATIVE

CHARACTERISTICS

Relevance

Reliability

Comparability

Consistency

ELEMENTS





Gains and Losses


Second level

Third

level

LO 4 Identify the qualitative

characteristics ofaccounting information.

Comparability and Consistency


21/39

Chapter2-21 LO 4 Identify the qualitative characteristics of accounting information.


Secondary Qualities:ComparabilityInformation that is measured and

reported in a similar manner for different

companies is considered comparable.Consistency - When a company applies the same

accounting treatment to similar events from periodto period.


22/39

Chapter2-22

Review:


Adherence to the concept of consistencyrequires that the same accounting principles be

applied to similar transactions for a minimum offive years before any change in principle isadopted.

False



23/39

Chapter2-23

ASSUMPTIONS

1. Economic entity

2. Going concern

3. Monetary unit

4. Periodicity

PRINCIPLES

1. Historical cost


3. Matching

4. Full disclosure

CONSTRAINTS

1. Cost-benefit

2. Materiality


4. Conservatism

OBJECTIVES




future cash flows

3. About enterprise


resources, and

changes in them

QUALITATIVE

CHARACTERISTICS

Relevance

Reliability

Comparability

Consistency

ELEMENTS





Gains and Losses


Second level

Third

levelElements

LO 5 Define the basic

elements of financialstatements.


24/39

Chapter2-24

Investment by ownersDistribution to owners


Revenue

Expenses

Gains

Losses

Second Level: Elements

Concepts Statement No. 6

defines ten interrelatedelements that relate to measuring the performance andfinancial status of a business enterprise.

AssetsLiabilities

Equity

Moment in Time Period of Time

LO 5 Define the basic elements of financial statements.


25/39

Chapter2-25


Exercise 2-3 Identify the element or elements associatedwith items below.

(a) Arises from peripheral orincidental transactions.

(b) Obligation to transfer

resources arising from apast transaction.

(c) Increases ownershipinterest.

(d) Declares and pays cashdividends to owners.

(e) Increases in net assets in aperiod from nonowner

sources. LO 5 Define the basic elements of financial statements.

(a)

Elements

(b)

(c)

(d)

(c)

(a)

(e)

Assets

Liabilities

EquityInvestment by owners



RevenueExpenses

Gains

Losses


26/39

Chapter2-26

(g)



(f) Items characterized byfuture economic benefit.

(g) Equals increase in netassets during the year,after adding distributionsto owners and subtractinginvestments by owners.

(h) Arises from incomestatement activities thatconstitute the entitysongoing major or central

operations. LO 5 Define the basic elements of financial statements.

(a)

Elements

(b)

(d)

(c)

(a)

(f)

(e)

(h)

(c)

(h)

Assets

Liabilities




RevenueExpenses

Gains

Losses


27/39

Chapter2-27

(g)

Assets

Liabilities




RevenueExpenses

Gains

Losses



(i) Residual interest in the netassets of the enterprise.

(j) Increases assets through

sale of product.(k) Decreases assets by

purchasing the companysown stock.

(l) Changes in equity duringthe period, except thosefrom investments byowners and distributions toowners.


(a)

Elements

(b)

(d)

(c)

(a)

(f)

(e)

(h)

(c)

(h)

(i)

(j)

(k)

(l)


28/39

Chapter2-28

Review:


According to the FASB conceptual framework, anentitys revenue may result from

a. A decrease in an asset from primary operations.b. An increase in an asset from incidentaltransactions.

c. An increase in a liability from incidental

transactions.d. A decrease in a liability from primary operations.


(CPA adapted)


29/39

Chapter

2-29

Third Level: Recognition and Measurement

The FASB sets forth most of these concepts in itsStatement of Financial Accounting Concepts No. 5,Recognition and Measurement in Financial Statementsof Business Enterprises.

ASSUMPTIONS

1. Economic entity

2. Going concern

3. Monetary unit

4. Periodicity

PRINCIPLES

1. Historical cost


3. Matching

4. Full disclosure

CONSTRAINTS

1. Cost-benefit

2. Materiality


4. Conservatism

LO 6 Describe the basic assumptions of accounting.


30/39

Chapter

2-30

Economic Entitycompany keeps its activityseparate from its owners and other businesses.

Going Concern - company to last long enough to fulfill

objectives and commitments.Monetary Unit- money is the common denominator.

Periodicity- company can divide its economic

activities into time periods.

Third Level: Assumptions



31/39

Chapter

2-31

Third Level: Assumptions


Brief Exercise 2-4Identify which basic assumption ofaccounting is best described in each item below.

(a) The economic activities of FedEx Corporationare divided into 12-month periods for thepurpose of issuing annual reports.

(b) Solectron Corporation, Inc. does not adjustamounts in its financial statements for theeffects of inflation.

(c) Walgreen Co. reports current and noncurrent

classifications in its balance sheet.(d) The economic activities of General Electric

and its subsidiaries are merged foraccounting and reporting purposes.

Periodicity

Going Concern

MonetaryUnit

EconomicEntity


32/39

Chapter

2-32

Historical Costthe price, established by theexchange transaction, is the cost.

Issues:

Historical cost provides a reliable benchmark formeasuring historical trends.

Fair value information may be more useful.

FASB issued SFAS 15X, Fair Value Measurements(2005).

Reporting of fair value information is increasing.

Third Level: Principles

LO 7 Explain the application of the basic principles of accounting.


33/39

Chapter

2-33

Revenue Recognition - generally occurs (1) whenrealized or realizable and (2) when earned.

Exceptions:

During Production.At End of Production

Upon Receipt of Cash




34/39

Chapter

2-34

Matching - efforts (expenses) should be matchedwith accomplishment (revenues) whenever it isreasonable and practicable to do so. Let the expensefollow the revenues.



Illustration 2-4 ExpenseRecognition


35/39

Chapter

2-35

Full Disclosureproviding information that is ofsufficient importance to influence the judgment anddecisions of an informed user.

Provided through:

Financial Statements

Notes to the Financial Statements

Supplementary information




36/39

Chapter

2-36



Brief Exercise 2-5Identify which basic principle ofaccounting is best described in each item below.

(a) Norfolk Southern Corporation reports revenuein its income statement when it is earned instead ofwhen the cash is collected.

(b) Yahoo, Inc. recognizes depreciation expense fora machine over the 2-year period during which thatmachine helps the company earn revenue.

(c) Oracle Corporation reports information about

pending lawsuits in the notes to its financialstatements.

(d) Eastman Kodak Company reports land on itsbalance sheet at the amount paid to acquire it, eventhough the estimated fair market value is greater.

RevenueRecognition

Matching

Full

Disclosure

HistoricalCost


37/39

Chapter

2-37

Cost Benefitthe cost of providing the informationmust be weighed against the benefits that can bederived from using it.

Materiality - an item is material if its inclusion or

omission would influence or change the judgment ofa reasonable person.

Industry Practice - the peculiar nature of someindustries and business concerns sometimes requires

departure from basic accounting theory.Conservatismwhen in doubt, choose the solution

that will be least likely to overstate assets andincome.

Third Level: Constraints

LO 8 Describe the impact that constraints haveon reporting accounting information.


38/39

Chapter

2-38

Brief Exercise 2-6 What accounting constraints areillustrated by the items below?

(a) Zips Farms, Inc. reports agricultural cropson its balance sheet at market value.

(b) Crimson Tide Corporation does not accrue acontingent lawsuit gain of $650,000.

(c) Wildcat Company does not disclose anyinformation in the notes to the financialstatements unless the value of the informationto users exceeds the expense of gathering it.

(d) Sun Devil Corporation expenses the cost ofwastebaskets in the year they are acquired.

IndustryPractice

Conservatism

Third Level: Constraints

Cost-Benefit

Materiality

LO 8 Describe the impact that constraints haveon reporting accounting information.


39/39

Chapter

2 39

Copyright 2006 John Wiley & Sons, Inc. All rights reserved.Reproduction or translation of this work beyond that permittedin Section 117 of the 1976 United States Copyright Act withoutthe express written permission of the copyright owner isunlawful. Request for further information should be addressed

to the Permissions Department, John Wiley & Sons, Inc. Thepurchaser may make back-up copies for his/her own use onlyand not for distribution or resale. The Publisher assumes noresponsibility for errors, omissions, or damages, caused by theuse of these programs or from the use of the informationcontained herein.

Copyright

Documents

CH 02 Conceptual Framework