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Chapter 1 Conceptual Framework Underlying Financial Accounting.

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Presentation on theme: "Chapter 1 Conceptual Framework Underlying Financial Accounting."— Presentation transcript:

1 Chapter 1 Conceptual Framework Underlying Financial Accounting

2 1. Explain the FASB conceptual framework. 2. Understand the relationship among the objectives of financial reporting. 3. Identify the general objective of financial reporting. 4. Describe the three specific objectives of financial reporting. ContinuedContinued

3 5. Discuss the types of useful information for investment and credit decision making. 6. Explain the qualities of useful accounting information. 7. Understand the accounting assumptions and conventions that influence GAAP. 8. Define the elements of financial statements.

4  How do we determine the amount of information to supply in general-purpose financial statements?  In what format?  Under what assumptions, principles, and constraints? The FASB’s Conceptual Framework

5  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.  To increase users’ understanding of and confidence in financial reporting.  To enhance comparability. The FASB’s Conceptual Framework

6 The FASB ’ a role is to... ◦ Establish consensus on topical accounting issues. ◦ Interpret accounting principles. ◦ Keep accounting practice as standardized as possible. The FASB’s Conceptual Framework

7  Accounting standards should be consistent with the framework.  New problems can be effectively resolved with reference to the framework.  User can benefit from a more comprehensive understanding of the accounting information in financial statements. The FASB’s Conceptual Framework

8 To develop a conceptual framework of accounting theory.

9 To establish standards (GAAP) for financial accounting practices. Charges Given to the FASB

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12 General Objective Provide information that is useful to present and potential investors, creditors, and other users in making rational investment, credit, and similar decisions.

13 Objectives of Financial Reporting by Business Enterprises  Target audience... ◦ External users of financial information ◦ Have a reasonable understanding of business and economic activities and are willing to study the information SFAC No. 1

14  Provide information that... ◦ Is useful in making rational investment, credit and other related decisions. ◦ Helps assess the amount, timing and uncertainty of future cash flows. ◦ Is accurate in reporting the economic resources of the business. ◦ Provide information about a company ’ s comprehensive income and its components. SFAC No. 1 Financial Reporting Objectives

15 Financial Reports Return on Investment Risk Financial Flexibility Liquidity Operating Capability Buy Hold Sell Extend Credit Continue Credit Deny Credit Communication Documents Types of Useful Information External Decision Making

16 Primary Decision-Specific Qualities Relevance Reliability Accounting Information Benefits>Costs Understandability Decision Usefulness Pervasive Constraint ContinuedContinued User- Specific Quality Overall Quality

17 Ingredients of Primary Qualities RelevanceReliability Predictive Value Feedback Value Timeli- ness Verifi- ability Representa- tional faithfulness Neu- trality Secondary and Interactive Qualities Materiality Comparability (including Consistency Threshold for Recognition Threshold for Recognition Hierarchy of Qualitative Characteristics

18 Accounting information is relevant if it can make a difference in a decision. SFAC No. 2

19 Qualitative Characteristics of Accounting Information  Primary Quality... Relevance. 1. Timeliness 2. Predictive value 3. Feedback value SFAC No. 2

20 Accounting information is reliable when it is reasonably free from error and bias, and faithfully represents what it is intended to represent. SFAC No. 2

21 Qualitative Characteristics of Accounting Information  Primary Quality... Reliability. 1. Representational faithfulness 2. Verifiability 3. Neutrality SFAC No. 2

22 Qualitative Characteristics of Accounting Information Secondary Qualities Comparability and Consistency SFAC No. 2

23 Comparability of accounting information enables users to identify and explain similarities and differences between two or more sets of economic facts. SFAC No. 3

24 Recognition and Measurement in Financial Statements of Business Enterprises 1. Recognition criteria 2. Measurement criteria 3. Environmental assumptions 4. Implementation principles 5. Implementation constraints 6. General-purpose financial statements SFAC No. 3

25 Recognition is the process of formally recording and reporting an item in the financial statements of a company. SFAC No. 3

26  Definition  Measurability  Relevance  Reliability SFAC No. 3 Recognition Criteria

27  Continued use of different attributes (historical cost, current cost, market value, etc.).  All monetary measurement based on nominal units of money. SFAC No. 4 Measurement Criteria

28  Separate entity assumption  Continuity assumption  Unit-of-measure assumption  Time period assumption SFAC No. 4 Environmental Assumptions

29 Entity The entity assumption assumes that a proprietorship, partnership, or corporation’s financial activities are distinguished from other financial organizations in keeping its own financial records and reports. SFAC No. 4 Environmental Assumptions

30 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. SFAC No. 4 Environmental Assumptions

31 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. SFAC No. 4 Environmental Assumptions

32 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 company’s financial statements. The FASB encourages companies to prepare supplemental disclosures about the impact of changing prices. SFAC No. 4 Environmental Assumptions

33  Cost principle  Realization principle  Matching concept  Full disclosure principle SFAC No. 4 Implementation Principles

34 Market Value $13,500 Market Value $13,500 Cost $16,000 Cost $16,000 Replacement Cost $13,000 Replacement Cost $13,000 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. SFAC No. 4 Implementation Principles

35 Historical Cost Which amount should be used? Cost $16,000 Cost $16,000 SFAC No.4 Implementation Principles

36 Realization is the process of converting noncash resources and rights into cash or rights to cash. SFAC No. 5 Implementation Principles

37 Realization principle: Two conditions must be met if therevenue principle is to be satisfied. Reasonable Assurance of Collection Substantial Completion of Earning Process SFAC No. 5 Implementation Principles

38 Accrual accounting is the process of relating the financial effects of transactions, events, and circumstances having cash consequences to the period in which they occur rather than to when the cash receipt or payment occurs. Matching Pinciple SFAC No. 5 Implementation Principles

39 Accrual accounting is the process of relating the financial effects of transactions, events, and circumstances having cash consequences to the period in which they occur rather than to when the cash receipt or payment occurs. 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. Matching Principle SFAC No. 5 Implementation Principles

40 Parenthetical Comments Disclosure Notes Supplemental Financial Statements Parenthetical Comments Disclosure Notes Supplemental Financial Statements Full Disclosure Principle SFAC No. 5 Implementation Principles

41  Cost-benefit constraint  Materiality constraint  Conservatism constraint  Industrial peculiarities SFAC No. 5 Implementation Constraints

42 Are benefits greater than costs? Cost-benefit Constraint SFAC No. 5 Implementation Constraints

43  The nature of the item.  The relative size rather than absolute size of an item.  The nature of the item.  The relative size rather than absolute size of an item. Materiality SFAC No. 5 Implementation Constraints

44 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. Conservatism SFAC No. 5 Implementation Constraints

45 1. Statement of Financial Position (Balance Sheet) 2. Earnings (Income Statement) 3. Cash Flows (Statement of Cash Flows) 4. Investment by and Distributions to Owners (Statement of Changes in Equity) General-Purpose Financial Statements

46  Elements of Financial Statements of Business Enterprises  Defines 10 elements of financial statements: ◦ Revenues, Expenses, Gains, Losses, Assets, Liabilities, Equity, Investment by owners, Distributions to owners and Comprehensive income. All 10 SFAC No. 6

47 A balance sheet is a financial statement that summarizes the financial position of a company on a particular date. It also is called a statement of financial position.

48  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. Elements of a balance sheet:

49 An income statement is a financial statement that summarizes the results of a company’s operations.

50  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 company ’ s ongoing major operation. Revenues increase the equity of a company. ContinuedContinued The elements of the income statement are:

51  Expenses are outflows or other using up of assets of a company or incurrences of liabilities during a period from delivering or producing goods, rendering services, or carrying out other activities that are the company’s ongoing major operation. Expenses decrease the equity of a company. ContinuedContinued The elements of the income statement are: Income Statement

52 Gains 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. ContinuedContinued The elements of the income statement are: Income Statement

53 Losses 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. The elements of the income statement are: Income Statement

54 Revenues increase the equity of the company Expenses decrease the equity of the company Income Statement

55 A statement of changes in equity summarizes the changes in a company’s equity for a period.

56  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. A statement of changes in equity contains two elements:

57 Comprehensive income includes all changes in equity during a period except those resulting form investments by owners and distributions to owners.

58 1. Financial and nonfinancial data. 2. Management ’ s analysis of the financial and nonfinancial data. 3. Forward-looking information. 4. Information about management and shareholders. 5. Background about the company. Framework of the Model

59 C hapter 1 Task Force Image Gallery clip art included in this electronic presentation is used with the permission of NVTech Inc.


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