2 Conceptual Framework For Financial Accounting First Level: Basic ObjectivesSecond Level: Fundamental ConceptsThird Level: Recognition and MeasurementNeedDevelopmentOverviewQualitative characteristicsBasic elementsBasic assumptionsBasic principlesConstraintsSummary of the structure
3 The FASB’s Conceptual Framework To develop a coherent set of standards and rules.To solve new and emerging practical problems.Establish amount of informationFormatAssumptions, principles, constraints
4 Development of Conceptual Framework The FASB has issued seven Statements of Financial Accounting Concepts (SFAC) for business enterprises.SFAC No.1 - Objectives of Financial Reporting.SFAC No.2 - Qualitative Characteristics of Accounting Information.SFAC No.3 - Elements of Financial Statements.SFAC No.5 - Recognition and Measurement in Financial Statements.SFAC No.6 - Elements of Financial Statements (replaces SFAC No. 3).SFAC No.7 - Using Cash Flow Information and Present Value in Accounting Measurements.SFAC No.8 - The Objective of General Purpose Financial Reporting and Qualitative Characteristics of Useful Financial Information (replaces SFAC No. 1 and No. 2)
5 Conceptual Framework Overview of the Conceptual Framework First Level = Basic ObjectivesSecond Level = Qualitative Characteristics and ElementsThird Level = Recognition, Measurement, and Disclosure Concepts.
6 Illustration 2-7Conceptual Framework for Financial Reporting
7 First Level: Basic Objectives 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.
8 “Objectives of Financial Reporting by Business Enterprises” Target audience . . .External users of financial informationHave a reasonable understanding of business and economic activities and are willing to study the information
9 Second Level: Fundamental Concepts Qualitative Characteristics“The FASB identified the Qualitative Characteristics of accounting information that distinguish better (more useful) information from inferior (less useful) information for decision-making purposes.”
10 Second Level: Qualitative Characteristics Illustration 2-2Hierarchy of Accounting Qualities
11 Second Level: Qualitative Characteristics Fundamental Quality—RelevanceTo be relevant, accounting information must be capable of making a difference in a decision.
12 Second Level: Qualitative Characteristics Fundamental Quality—RelevanceFinancial information has predictive value if it has value as an input to predictive processes used by investors to form their own expectations about the future.
13 Second Level: Qualitative Characteristics Fundamental Quality—RelevanceRelevant information also helps users confirm or correct prior expectations.
14 Second Level: Qualitative Characteristics Fundamental Quality—RelevanceInformation is material if omitting it or misstating it could influence decisions that users make on the basis of the reported financial information.
15 Second Level: Qualitative Characteristics Fundamental Quality—Faithful RepresentationFaithful representation means that the numbers and descriptions match what really existed or happened.
16 Second Level: Qualitative Characteristics Fundamental Quality—Faithful RepresentationCompleteness means that all the information that is necessary for faithful representation is provided.
17 Second Level: Qualitative Characteristics Fundamental Quality—Faithful RepresentationNeutrality means that a company cannot select information to favor one set of interested parties over another.
18 Second Level: Qualitative Characteristics Fundamental Quality—Faithful RepresentationAn information item that is free from error will be a more accurate (faithful) representation of a financial item.
19 Second Level: Qualitative Characteristics Enhancing QualitiesInformation that is measured and reported in a similar manner for different companies is considered comparable.
20 Second Level: Qualitative Characteristics Enhancing QualitiesVerifiability occurs when independent measurers, using the same methods, obtain similar results.
21 Second Level: Qualitative Characteristics Enhancing QualitiesTimeliness means having information available to decision-makers before it loses its capacity to influence decisions.
22 Second Level: Qualitative Characteristics Enhancing QualitiesUnderstandability is the quality of information that lets reasonably informed users see its significance.
23 Second Level: Basic Elements Concepts Statement No. 6 defines ten interrelated elements that relate to measuring the performance and financial status of a business enterprise.“Moment in Time”“Period of Time”AssetsLiabilitiesEquityInvestment by ownersDistribution to ownersComprehensive incomeRevenueExpensesGainsLosses
24 Third Level: Basic Assumptions Economic Entity – company keeps its activity separate 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.
25 Third Level: Basic Principles Measurement Principle – The most commonly used measurements are based on historical cost and fair value.Issues:Historical cost provides a reliable benchmark for measuring historical trends.Fair value information may be more useful.Recently the FASB has taken the step of giving companies the option to use fair value as the basis for measurement of financial assets and financial liabilities.Reporting of fair value information is increasing.
26 Third Level: Basic Principles Revenue Recognition - generally occurs (1) when realized or realizable and (2) when earned.Exceptions:Illustration 2-5Timing of Revenue Recognition
27 Third Level: Basic Principles Expense Recognition - “Let the expense follow the revenues.”Illustration Expense Recognition
28 Third Level: Basic Principles Full Disclosure – providing information that is of sufficient importance to influence the judgment and decisions of an informed user.Provided through:Financial StatementsNotes to the Financial StatementsSupplementary information
29 Third Level: Constraints Cost Constraint – cost of providing information must be weighed against the benefits that can be derived from using it.Industry Practice - the peculiar nature of some industries and business concerns sometimes requires departure from basic accounting theory.
30 DOUBLE-ENTRY ACCOUNTING MODEL A = L OE(Assets) (Liabilities) (Owners’ Equity)
31 BASIC ACCOUNTING EQUATION [Corporation] Assets = Liabilities + Stockholders’ EquityContributed(Paid-in)CapitalRetainedEarningsAll transactions (regardless of complexity) can be explained by application of this equationTransaction analysis can always be accomplished using this algebraic technique (DEBITS AND CREDITS ARE NOT REQUIRED AND ARE NOT THE ESSENCE OF ACCOUNTING!!!)The true reason for the double-entry (dual aspect) approach is EXPLANATION!!ParValueExcessOverParNet Income (+)Net loss (-)Dividends (-)DeclaredRevenues & Gains (+)Expenses & Losses (-)