1. The Conceptual Framework and Objectives of Financial Reporting
Chapter 1
The Conceptual Framework and Objectives of Financial Reporting

2. What is Accounting Used For?
Decision Making
Evaluation of past performance
Expectations of future performance
Allocation of Resources

3. Free enterprise principle
Resources will flow to the segments of the economy
that will use them most efficiently in the creation of new wealth

4. Accounting Information
Role of Accounting
Accounting Information
Investors
Efficient Markets Hypothesis—
Implies alternative accounting methods will not significantly affect stock prices
Implies investors receive information form a variety of sources

5. Chapter 1 -- Learning Objective
2. Trace the evolution of generally accepted accounting principles
GAAP

6. GAAP
A consensus
The conventions, rules, and procedures necessary to define accepted accounting practice

7. Sources of GAAP
Committee on Accounting Procedures
Accounting Principles Board
Financial Accounting Principles Board

8. Committee on Accounting Procedure CAP 1939 - 1959
First private body concerned with writing accounting rules
Issued 51 Accounting Research Bulletins
Members were practicing CPAs
An “ad hoc” approach

9. Accounting Principles Board APB 1959 - 1973
Appointed by the AICPA
Primarily from public accounting
Issued 31 APB Opinions
Criticized for failing to deal with problems on a timely basis
Many saw a need for independence

10. Financial Accounting Foundation FAF Established 1973
Appoints members of Financial Accounting Standards Board (FASB)
Appoints members of Financial Accounting Standards Advisory Committee (FASAC)
Provides financial support to FASB
Contributions from industry & CPA firms
Wheat committee

11. Financial Accounting Standards Board FASB Established 1973
7 members
Members are full time, well paid
Responsible only to FAF
Passage of standards requires 5 out of 7 votes

12. Securities and Exchange Commission
Appointed by President
Reports to Congress
Final authority on reporting by public companies

13. International Accounting Standards
International Accounting Standards Committee
Standards less specific
“Principle Based”
Not allowed by SEC

14. Accounting Standard Setting
A political process
Example—options
Congress, SEC,
EITF 13

15. Chapter 1 -- Learning Objective
3. Relate the objectives of financial reporting as stated in the conceptual framework to the accounting process

16. Conceptual Framework
Statements of Financial Accounting Concepts (SFACs)
Purpose:
Establish the objectives and concepts to be used by the FASB in developing standards for financial reporting
Why is there a conceptual framework?
The need for a logical and cohesive set of interrelated concepts serve as a guide for the development of financial accounting and reporting standards

17. Conceptual Framework SFACs
Objectives of Financial Reporting
Qualitative Characteristics
Objectives for Nonbusiness Organizations
Recognition & Measurement
Elements of Financial Statements

18. Objectives of Financial Reporting SFAC No. 1
To provide information:
1. Useful in investment and credit decisions
2. Useful in assessing future cash flows
3. About enterprise resources, claims and changes
Key is decision making
Liquidity, Solvency, Financial Flexibility, Profitability

19. Chapter 1 -- Learning Objective
4. Interpret the meaning of the qualitative characteristics of accounting information enumerated in the conceptual framework

20. Objectives Useful for decision making
Information about future cash flows
Information about resources, claims to resources, changes in resources
Liquidity
Solvency
Flexibility
Profitability

21. Qualitative Characteristics SFAC No. 2
Primary Qualities
Understandability
Relevance
Reliability
Secondary Qualities
Comparability
Consistency
Qualities to make F.S. most useful for decision making
Must be Understandable

22. The capacity for information to make a difference
Relevance
The capacity for information to make a difference
Predictive Value
Feedback Value
Timeliness

23. Reliability User has confidence in the information: Verifiability
Representational Faithfulness
Neutrality
Representational Faithfulness to Underlying Economic Events
Neutrality—Free from Bias

24. Secondary Qualities Comparability—With other enterprises
Consistency—Period to Period
Changes in accounting must be to Better principles

25. Measurement and reporting practices are affected by:
Constraints
Measurement and reporting practices are affected by:
Cost/benefits
Materiality
Industry practices

26. Chapter 1 -- Learning Objective
5. Understand the assumptions and conventions underlying the recognition and measurement of accounting data for financial reporting

27. Recognition and Measurement SFAC No. 5
Reporting an item in the financial statements
Measurement
The amount reported for an item in financial statements

28. Recognition Criteria Definition Measurability Relevance Reliability
Must meet definition of an element of financial statements found in SFAC No. 6
Measurability
Must be measurable with sufficient reliability
Relevance
Must be capable of making a difference
Reliability
Must be representationally faithful, verifiable & neutral

29. Basic Accounting Assumptions:
Economic entity
Going concern (Continuity)
Periodicity
Monetary unit
Monetary Unit—must be stable
Ex. Cost of gas 10 years ago

30. Basic Conventions and Practices
Cost or other measurement attributes
Revenue recognition
Matching
Conservatism
Full disclosure
Matching revenues to expenses
Ex. depreciation

31. Chapter 1 -- Learning Objective
6. Distinguish among the elements of the financial statements

32. Elements of Financial Statements SFAC No. 6
Basic Building Blocks

33. Elements of Financial Statements
Assets
Liabilities
Equity
Investments by owners
Distributions to owners
Comprehensive Income
Revenues
Expenses
Gains
Losses
Balance Sheet
Assets—future economic benefits
Liabilities—future claims against assets
Income Statement

34. Chapter 1 -- Learning Objective
7. Understand how accounting information is used in investment decision models

35. Investment Decision Model
Factors
Operating efficiency
Capital generation
Asset productivity
Financial leverage
Income Statement
Goal
Growth potential
Balance Sheet
Also consider downside risk

36. Chapter 1 -- Learning Objective
8. Develop an appreciation of ethical and moral considerations in business

37. Decision Model Determine the Facts Define the ethical issues
Identify major values
Specify the Alternatives
Compare values and alternatives
Assess consequences
Decide
Relativism—widespread acceptance
Absolutism—rules
Utilitarianism--stakeholders

38. Decision Model for Ethical Dilemmas
1. Determine the facts
2. Define the ethical issue
3. Identify major values
4. Specify the alternatives
5. Compare values and alternatives
6. Assess the consequences
7. Make the decision
Problem