Chapter 2

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Chapter 2



Conceptual Framework

For Financial Reporting

1

Introduction


The conceptual accounting framework is
a foundation and guideline for the
establishment of accounting standards.

FASB was the first promulgating board to
develop a formal conceptual framework
through the issue of Statements of
Financial Accounting Concepts
(SFACs).

These SFACs are not GAAP; rather they
are guidelines to the development of
GAAP.



2

Development of

Conceptual Framework

SFAC 1, 1978:
Objectives of Financial
Reporting by Business Enterprises*

SFAC 2, 1980:
Qualitative Characteristics of
Accounting Information*

SFAC 3, 1980:
Elements of Financial
Statements of Business Enterprises*

SFAC 5, 1984:
Recognition and Measurement
in Financial Statements of Business
Enterprises

SFAC 6,1985
: Elements of Financial
Statements

(replacement of SFAC 3)

*superseded

3

Development of

Conceptual Framework

SFAC 7, 2000:
Using Cash Flow Information and
Present Value in Accounting Measurements


SFAC 8, 2010:
Conceptual Framework for
Financial Reporting


Chapter 1: The Objective of General Purpose


Financial reporting


Chapter 3: Qualitative Characteristics of


Useful Financial Information



Coordinating with IASB; more chapters to come.


4

Overview


Overview of the Conceptual Framework
-

see p. 65 of text.


Level 1: Objective of Financial Reporting

Level 2: Qualitative Characteristics




Elements of Financial Statements

Level 3: Recognition, Measurement and




Disclosure Concepts

5

Objective of Financial Reporting


SFAC 8, Chapter 1:


“The objective of general
-
purpose financial
reporting is to provide financial
information about the reporting entity that
is useful to present and potential equity
investors, lenders, and other creditors in
making decisions about providing
resources to the entity.”

6

Fundamental Quality
-

Relevance

Relevance


makes a difference in decisions
of users of financial information.


Components:


Predictive Value


useful in making
estimations about the future.



Confirmatory Value


offers verification of
prior estimations.



Materiality


requires appropriate reporting
to allow the users to incorporate into their
decision process (immaterial activities may
be reported in non
-
GAAP ways).

7

Fundamental Quality

Faithful
Representation

Faithful Representation


the numbers
and descriptions match what they are
describing.

Components:


Completeness


all information that is
necessary for faithful representation is
included.


Neutrality


free from bias.


Free from Error


an accurate
representation of the information.

8

Enhancing Qualities

Comparability


company to company,
information is calculated and reported in a
similar manner.

Consistency


for a particular company, year to
year, the same techniques and
measurements are used, or the change in
methods is disclosed.

Verifiability

when independent measurers,
using the same methods, obtain similar
results.

Timeliness


reporting information in a
sufficiently short time period, so that the
information is still useful.

Understandability


clear presentation that
allows for proper use of the information.

9

Elements

From SFAC 6


See page 55 for elements.

Note “Comprehensive Income” is currently
being incorporated into financial
statements.

Basic definition:


Net Income (Income Statement)

+ Other Comprehensive Income (St. of SE)

= Comprehensive Income

10

Recognition and Measurement

Basic Assumptions:


Economic Entity


Going Concern


Monetary Unit


Periodicity

Basic Principles:


Measurement


Revenue Recognition


Expense Recognition


Full Disclosure

Constraints:


Cost


Industry Practices


11

Economic Entity Assumption


A company is assumed to be a separate
economic entity that can be identified
and measured.


This concept helps determine the scope
of financial statements.


Many businesses own subsidiaries, and
the subsidiaries are separate legal
entities from the parent, though the
combined reporting would represent the
economic entity.

12

Going Concern Assumption


The life of an economic entity is
assumed to be indefinite.


Assets, defined as having future
economic benefit, require this
assumption.


Allocation of costs to future periods is
supported by the going concern
assumption.

13

Monetary Unit Assumption


The monetary unit assumption is that
money is an appropriate basis for
accounting measurement and analysis,


The monetary unit assumption also
implies that the dollar (in the US) is a
stable unit of measure, and that the
purchasing power a dollar remains
stable.

14

Periodicity Assumption


This assumption requires that
companies report in discrete time
periods, like months, quarters and
years.


This allows the companies to send out
interim reports, and inform shareholders
of the activities of the company.

15

16

Measurement Principle


The measurement principle consists of mixed
attributes.


Historical cost


the acquisition price of an
asset is considered to be the primary
reported value for an asset or liability, unless
other values are more appropriate.


Fair value


a market based measure that is
often more relevant that cost. Current use of
fair value for investments is increasing, and
international standards include even more fair
value applications.

17

The Revenue Recognition Principle


This principle determines when
revenues
can be recognized.


Revenue recognized when realized (or
realizable) and earned.


This principle triggers the matching principle,
which is necessary for determining the
measure of performance.


The most common point of revenue
recognition is when goods or services are
transferred or provided to the buyer (at
delivery); alternative recognition techniques
are discussed in later chapters.

18

The Expense Recognition Principle


Expense recognition focuses on the
timing

of
recognition of
expenses

after revenue recognition
has been determined.


This principle states that the efforts of a given
period (expenses) should be matched against the
benefits (revenues) they generate.


For example, the cost of inventory is initially
capitalized as an asset on the balance sheet; it is
not recorded in Cost of Goods Sold (expense) until
the sale is recognized.

19

Full Disclosure


Full disclosure requires the reporting of
information that is of sufficient importance to
influence the judgment and decisions of an
informed user.



Disclosure of information may be found in the
body of the financial statements, in the notes
to the financial statements, or in other
supplementary disclosures.

20

Constraints


Cost Constraint


requires the FASB to
consider the cost to the company of
implementing a new standard and compare it
to the benefits of the standard to the users.


Industry Practice


some industries have
developed long
-
standing practices for
treatment of certain accounting issues; the
treatments are not considered GAAP, but are
allowed for the industry for comparability and
consistency.


Note: one constraint is no longer mentioned
in the concepts: conservatism.