I 2 Financial Reporting: Its Conceptual Framework ntermediate Accounting I 中级会计学 Accounting School · Zhongnan University of Economics & Law

1. FASB conceptual framework Intermediate Accounting 2 Financial Reporting: Its Conceptual Framework 1. FASB conceptual framework FASB was given two charges: To develop a conceptual framework of accounting theory. To establish standards (GAAP) for financial accounting practices.

Functions of FASB Conceptual Framework Intermediate Accounting 2 Financial Reporting: Its Conceptual Framework Functions of FASB Conceptual Framework 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. Continued

Functions of FASB Conceptual Framework Intermediate Accounting 2 Financial Reporting: Its Conceptual Framework Functions of FASB Conceptual Framework To increase users’ understanding of and confidence in financial reporting. To enhance comparability.

Statements of Financial Accounting Concepts issued by FASB Intermediate Accounting 2 Financial Reporting: Its Conceptual Framework Statements of Financial Accounting Concepts issued by FASB Concepts Statement No. 1 Objectives of Financial Reporting by Business Enterprises (Issue Date 11/78) Concepts Statement No. 2 Qualitative Characteristics of Accounting Information (Issue Date 5/80) Continued

Statements of Financial Accounting Concepts issued by FASB Intermediate Accounting 2 Financial Reporting: Its Conceptual Framework Statements of Financial Accounting Concepts issued by FASB Concepts Statement No. 3 Elements of Financial Statements of Business Enterprises (Issue Date 12/80, replaced by No. 6 in 1985) Concepts Statement No. 4 Objectives of Financial Reporting by Nonbusiness Organizations (Issue Date 12/80) Continued

Statements of Financial Accounting Concepts issued by FASB Intermediate Accounting 2 Financial Reporting: Its Conceptual Framework Statements of Financial Accounting Concepts issued by FASB Concepts Statement No. 5 Recognition and Measurement in Financial Statements of Business Enterprises (Issue Date 12/84) Concepts Statement No. 6 Elements of Financial Statements—a replacement of FASB Concepts Statement No. 3 (incorporating an amendment of FASB Concepts Statement No. 2) (Issue Date 12/85) Continued

Statements of Financial Accounting Concepts issued by FASB Intermediate Accounting 2 Financial Reporting: Its Conceptual Framework Statements of Financial Accounting Concepts issued by FASB Concepts Statement No. 7 Using Cash Flow Information and Present Value in Accounting Measurements (Issue Date 2/00)

Relationship of Conceptual Framework and Standard-Setting Process Intermediate Accounting 2 Financial Reporting: Its Conceptual Framework Relationship of Conceptual Framework and Standard-Setting Process Conceptual Framework Objectives and Concepts Terms Identify goals and purpose of accounting Guide the selection of events to be accounted for, the measurement of these events, and the means of summarizing and communicating the information to external users, Purpose Statements of Financial Accounting Concepts Documents Continued

Relationship of Conceptual Framework and Standard-Setting Process Intermediate Accounting 2 Financial Reporting: Its Conceptual Framework Relationship of Conceptual Framework and Standard-Setting Process Standard Setting From Objectives and Concepts Standards Establish methods and procedures for measuring, summarizing, and communicating financial accounting information to external users. Statements of Financial Accounting Concepts Statements of Financial Accounting Standards

Conceptual Framework Overview Intermediate Accounting 2 Financial Reporting: Its Conceptual Framework Conceptual Framework Overview Objectives of Financial Reporting Qualitative Characteristics of Accounting Information Elements of Financial Statements Recognition and Measurement Concepts Assumptions Principles Constraints

Objectives of Financial Reporting—broad objectives Intermediate Accounting 2 Financial Reporting: Its Conceptual Framework Objectives of Financial Reporting—broad objectives Financial reporting should provide information that is useful to present and potential investors and creditors and other users in making rational investment, credit, and similar decisions. Usefulness

Objectives of Financial Reporting Intermediate Accounting 2 Financial Reporting: Its Conceptual Framework Objectives of Financial Reporting Financial reporting should provide information that is understandable to one who has a reasonable knowledge of accounting and business and who is willing to study and analyze the information presented. Understandability

Objectives of Financial Reporting Intermediate Accounting 2 Financial Reporting: Its Conceptual Framework Objectives of Financial Reporting While there are many potential users of financial reports, the objectives are directed primarily toward investors and creditors. Target Audience

Objectives of Financial Reporting—specific objectives Intermediate Accounting 2 Financial Reporting: Its Conceptual Framework Objectives of Financial Reporting—specific objectives Financial reporting should provide information that is useful in assessing amounts, timing, and uncertainty (risk) of prospective cash flows. Assessing Future Cash Flows

Objectives of Financial Reporting—specific objectives Intermediate Accounting 2 Financial Reporting: Its Conceptual Framework Objectives of Financial Reporting—specific objectives Financial reporting should also provide information about an enterprise’s assets, liabilities, and owners’ equity to help investors, creditors, and others evaluate the financial strengths and weaknesses of the enterprise and its liquidity and solvency. Evaluating Economic Resources

Objectives of Financial Reporting—specific objectives Intermediate Accounting 2 Financial Reporting: Its Conceptual Framework Objectives of Financial Reporting—specific objectives Information about enterprise earnings, measured by accrual accounting, generally provides a better basis for forecasting future performance than does information about current cash receipts and disbursements. Primary Focus on Earnings

Types of useful information Intermediate Accounting 2 Financial Reporting: Its Conceptual Framework Types of useful information Return on investment provides a measure of overall company performance. Risk is the uncertainty of unpredictability of the future results of a company. Financial flexibility is the ability of a company to take effective actions to change the amounts and timing of cash flows. Continued

Types of useful information Intermediate Accounting 2 Financial Reporting: Its Conceptual Framework Types of useful information Liquidity is the term used to describe how quickly an asset can be converted into cash or a liability paid. Operating capability refers to the ability of a company to maintain a given physical level of operation.

3. Qualitative characteristics of accounting information Intermediate Accounting 2 Financial Reporting: Its Conceptual Framework 3. Qualitative characteristics of accounting information FASB Statement of Financial Accounting Concepts No. 2 specifies qualitative characteristics of accounting information that accounting information should possess in order to be most useful. Different from China, FASB has set hierarchy of qualitative characteristics.

Hierarchy of Qualitative Characteristics Intermediate Accounting 2 Financial Reporting: Its Conceptual Framework Hierarchy of Qualitative Characteristics Accounting Information Benefits>Costs Understandability Pervasive Constraint Decision Usefulness User-Specific Quality Relevance Reliability Overall Quality Primary Decision-Specific Qualities Continued

Hierarchy of Qualitative Characteristics Intermediate Accounting 2 Financial Reporting: Its Conceptual Framework Hierarchy of Qualitative Characteristics Relevance Reliability Comparability (including Consistency Predictive Value Feedback Value Timeli-ness Verifi-ability Representa-tional faithfulness Neu-trality Secondary and Interactive Qualities Threshold for Recognition Ingredients of Primary Qualities Materiality

Relevance: making a difference Intermediate Accounting 2 Financial Reporting: Its Conceptual Framework Relevance: making a difference Predictive Value Helps a decision maker predict future consequences based on information about past transactions and events. Feedback Value Helps to confirm or change a decision maker’s beliefs based on whether the information matches what was expected. Timeliness Quality of information that is provided on a timely basis.

Free from error and represents what it claims to represent. Intermediate Accounting 2 Financial Reporting: Its Conceptual Framework Reliability Free from error and represents what it claims to represent. Verifiability Reported information should be based on objectively determined facts that can be verified by other accountants using the same measurement methods. Representational Faithfulness The amounts and descriptions reported in the financial statements should reflect the actual results of economic transactions and events. Neutrality The information should be presented in an unbiased manner; fairness.

Intermediate Accounting 2 Financial Reporting: Its Conceptual Framework Comparability Comparability requires that similar events be accounted for in the same manner on the financial statements of (1) different companies and (2) for a particular company for different periods (consistency).

Intermediate Accounting 2 Financial Reporting: Its Conceptual Framework Materiality Is the item large enough to influence the decision of a user of the information?

4. Accounting assumptions and conventions Intermediate Accounting 2 Financial Reporting: Its Conceptual Framework 4. Accounting assumptions and conventions Certain assumptions and conventions have influenced the development of generally accepted accounting principles. These are similar with those of China.

Intermediate Accounting 2 Financial Reporting: Its Conceptual Framework 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.

Intermediate Accounting 2 Financial Reporting: Its Conceptual Framework 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.

Intermediate Accounting 2 Financial Reporting: Its Conceptual Framework 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.

Intermediate Accounting 2 Financial Reporting: Its Conceptual Framework 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.

Intermediate Accounting 2 Financial Reporting: Its Conceptual Framework 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.

Realization and Recognition Intermediate Accounting 2 Financial Reporting: Its Conceptual Framework Realization and Recognition Realization is the process of converting noncash resources and rights into cash or rights to cash. Recognition is the process of formally recording and reporting an item in the financial statements of a company.

Matching and Accrual Accounting Intermediate Accounting 2 Financial Reporting: Its Conceptual Framework Matching and Accrual Accounting 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.

Intermediate Accounting 2 Financial Reporting: Its Conceptual Framework Conservatism 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.

5. Elements of financial statements Intermediate Accounting 2 Financial Reporting: Its Conceptual Framework 5. Elements of financial statements Main financial statements: Balance Sheet Income statement Statement of Cash Flows Statement of Changes in Equity

Elements of a balance sheet Intermediate Accounting 2 Financial Reporting: Its Conceptual Framework Elements of a balance sheet 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 Income Statement Intermediate Accounting 2 Financial Reporting: Its Conceptual Framework Elements of Income Statement 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. Continued

Elements of Income Statement Intermediate Accounting 2 Financial Reporting: Its Conceptual Framework Elements of Income Statement Expenses are outflows or other using up of assets of a company or incurrence 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. Continued

Elements of Income Statement Intermediate Accounting 2 Financial Reporting: Its Conceptual Framework Elements of Income Statement 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. Continued

Elements of Income Statement Intermediate Accounting 2 Financial Reporting: Its Conceptual Framework Elements of Income Statement 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.

Elements of Statement of Cash Flows Intermediate Accounting 2 Financial Reporting: Its Conceptual Framework Elements of Statement of Cash Flows Operating cash flows are the flows of cash from acquiring, selling, and delivering goods for sale, as well as providing services. Investing cash flows are the flows of cash from acquiring and selling investments, property, plant, and equipment, as well as from lending money and collecting on loans. Financing cash flows are the flows of cash to and from the owners and long-term creditors.

Elements of Statement of Changes in Equity Intermediate Accounting 2 Financial Reporting: Its Conceptual Framework Elements of Statement of Changes in Equity 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.

6. Comparison of accounting concepts in China and in U.S. Intermediate Accounting 2 Financial Reporting: Its Conceptual Framework 6. Comparison of accounting concepts in China and in U.S. Could you compare accounting concepts in China and in U.S.?

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