1. Conceptual Framework Underlying Financial Accounting
Chapter 1
Conceptual Framework Underlying Financial Accounting

2. Learning Objectives Continued Explain the FASB conceptual framework.
Understand the relationship among the objectives of financial reporting.
Identify the general objective of financial reporting.
Describe the three specific objectives of financial reporting.
Continued 2 2 2 4

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

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

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

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

7. The FASB’s Conceptual Framework
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.

8. Charges Given to the FASB
To develop a conceptual framework of accounting theory.

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

10. Relationship of Conceptual Framework and Standard-Setting Process

11. Conceptual Framework Projects for Financial Accounting and Reporting

12. Objectives of Financial Reporting
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. SFAC No. 1 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

14. SFAC No. 1 Financial Reporting Objectives
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.

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

16. 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

17. 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

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

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

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

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

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

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

24. SFAC No. 3
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

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

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

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

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

29. SFAC No. 4 Environmental Assumptions
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.

30. SFAC No. 4 Environmental Assumptions
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.

31. SFAC No. 4 Environmental Assumptions
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.

32. SFAC No. 4 Environmental Assumptions
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.

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

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

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

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

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

38. SFAC No. 5 Implementation Principles
Matching Pinciple
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.

39. SFAC No. 5 Implementation Principles
Matching Principle
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.
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.

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

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

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

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

44. SFAC No. 5 Implementation Constraints
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.

45. General-Purpose Financial Statements
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)

46. SFAC No. 6 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

47. It also is called a statement of financial position.
Balance Sheet
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. Balance Sheet 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.

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

50. Income Statement The elements of the income statement are: Continued
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

51. Income Statement The elements of the income statement are:
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.
Continued

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

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

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

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

56. Statement of Changes in Equity
A statement of changes in equity contains two elements:
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.

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

58. Model of Business Reporting
Framework of the Model
Financial and nonfinancial data.
Management’s analysis of the financial and nonfinancial data.
Forward-looking information.
Information about management and shareholders.
Background about the company.

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