Transcript Conceptual Framework Underlying Financial Accounting

Standards and the Conceptual
Framework Underlying Financial
Accounting
CHAPTERS 1 & 2
Who sets the standards?
US
 FASB - Financial Accounting Standards Board
 GAAP – Generally Accepted Accounting Principles
International
 IASB – International Accounting Standards Board
 IFRS – International Financial Reporting Standards
[also known as iGAAP]
Transition to International GAAP [IFRS]
 US GAAP and International GAAP [iGAAP] are in
the process of convergence. The SEC tentative
timeline requires that all US publicly traded
companies use iGAAP by 2016.
 iGAAP tends to be simpler and less stringent in its
accounting and disclosure requirements. This
difference in approach has resulted in a debate about
the merits of “principle-based” versus “rulebased” standards.
Conceptual Framework
 The IASB and the FASB have agreed to work on a
joint project to develop a common conceptual
framework – where differences will be resolved.
 Currently, US GAAP and iGAAP follow a very similar
conceptual framework.
ASSUMPTIONS
PRINCIPLES
CONSTRAINTS
1. Economic entity
1. Measurement
1. Cost-benefit
2. Going concern
2. Revenue recognition
2. Materiality
3. Monetary unit
3. Expense recognition
3. Industry practice
4. Periodicity
4. Full disclosure
4. Conservatism
QUALITATIVE
CHARACTERISTICS
Relevance
Reliability
Comparability
Illustration 2-7
Conceptual
Framework for
Financial Reporting
Consistency
Third
level
ELEMENTS
Assets, Liabilities, and Equity
Investments by owners
Distribution to owners
Comprehensive income
Revenues and Expenses
Gains and Losses
OBJECTIVES
1. Useful in investment
and credit decisions
2. Useful in assessing
future cash flows
3. About enterprise
resources, claims to
resources, and
changes in them
Second level
First level
LO 2 Describe the FASB’s
efforts to construct a
conceptual framework.
Basic Objectives of Reporting
To provide information that is:
•
Understandable
•
Useful to those making investment and credit decisions
•
Helpful to users to assess the amounts, timing, and
certainty or uncertainty of future cash flows
•
About economic resources, the claims to those
resources, and the changes in them.
Qualitative Characteristics
Primary Qualities
Relevance – capable of making a difference in a
decision
- Predictive value
- Feedback value
- Timeliness
Qualitative Characteristics
Primary Qualities
Reliability – assurance that information has
integrity to the extent that it is
-Verifiable
-a Faithful Representation
-Free of Error and Bias
Qualitative Characteristics
Secondary Qualities
Comparability – Information that has been
measured and reported in a similar manner for
different enterprises is considered comparable.
Consistency – applying the same accounting
treatment to similar events, from period to period.
Basic Elements of Financial Statements
Assets – probable future economic benefits
Liabilities – probable future sacrifices of
economic benefits
Equity – residual interest in the assets of an entity
that remains after deducting its liabilities (also
referred to as the ownership interests).
Basic Elements of Financial Statements
Comprehensive Income – Includes all changes in equity
(presented on the Stmt of Owners’ Equity) during a period
except those resulting from investments by owners and
distributions to owners.
ex) Net Income
+/+/+/-
Unrealized Gains/Losses
Foreign Currency Translations
Minimum Pension Liability
Adjustment
Basic Elements of Financial Statements
Revenues – Inflows or other enhancements of
assets of an entity or settlement of its liabilities
occurring from ongoing major or central
operations of the business
Expenses – Outflows or other using up of assets or
incurrences of liabilities occurring from ongoing
major or central operations of a business
Basic Elements of Financial Statements
Gains – Increases in equity (net assets) from
peripheral or incidental transactions of an entity
Losses – Decreases in equity (net assets) from
peripheral or incidental transactions of an entity
(ex. Gains/Losses from sale of an operational asset,
or gains/losses from settlement of a lawsuit)
Basic Assumptions
1. Economic Entity Assumption – economic
activity can be identified with a particular unit of
accountability.
The activity of a business enterprise can be kept
separate and distinct from its owners and any
other business unit.
Basic Assumptions
2. Going Concern Assumption – most
accounting methods assume that the business
enterprise will have a long life.
Depreciation and amortization policies are just
one example where we must assume a business
permanence in the future to justify the policies
as appropriate.
Only where liquidation appears imminent is
the assumption inapplicable.
Basic Assumptions
3.
Monetary Unit Assumption – money is the common
denominator of economic activity and provides an
appropriate basis for accounting measurement and
analysis.
We assume that the unit of monetary measure remains
relatively stable and do not adjust for inflation from one
year to the next
Basic Assumptions
4. Periodicity Assumption – implies that the
ongoing economic activities of an enterprise can
be divided into artificial time periods.
It is most common to break the financial
accounting cycle into months, quarters, and
years.
Basic Principles
1.
Historical Cost Principle – GAAP requires that most
assets and liabilities be accounted for and reported on
the basis of acquisition price.
Using historical cost, as opposed to other valuations
such as fair value or replacement cost, provides users
with a stable, reliable, and consistent benchmark that
can be relied upon to establish historical trends.
Basic Principles
2.
Revenue Recognition Principle – Revenues are
recognized when
a) realized or realizable
b) earned
Realized – revenues are realized when goods or services
are exchanged for cash or claims to cash
Realizable – revenues are realizable when assets
received or held are readily convertible into cash or
claims to cash
Earned – revenues are earned when the entity has
substantially accomplished what it must do to be
entitled to the benefits represented by the revenues.
Basic Principles
3.
Matching Principle – dictates that efforts (expenses)
be matched with accomplishments (revenues) whenever
it is reasonable and practical to do so.
Expenses are recognized in the period the work
(service) or product actually makes its contribution to
revenue, thereby, “matching” expenses to revenues they
helped create in the appropriate period.
ex)
the allowance method to account for
bad debt or depreciation methods
Basic Principles
4.
Full Disclosure Principle – sufficient
information must be provided to
a) disclose matters that make a difference
to users
b) make the information understandable
Information may be disclosed
a) within the main body of financial
statements
b) in the notes to those statements
c) as supplementary information
Constraints
1.
Cost-Benefit Relationship – The costs of providing
the information must be weighed against the benefits
that can be derived from using the information.
Examples of costs to provide particular information
that must be considered include costs for
a) collecting and processing
b) auditing
c) potential litigation
d) disclosure to competitors
Benefits are generally more difficult to quantify than
costs.
Constraints
2.
Materiality – An item is material if its inclusion or
omission would influence or change the judgment of a
reasonable person. Information is considered
immaterial or irrelevant if would have no impact on a
decision maker.
The size and importance of disclosing certain
information will be relative from one company to
another. What’s material to Joe’s Discount Tire may be
immaterial to Firestone.
Constraints
3. Industry Practice – The peculiar nature of
some industries and business concerns
sometimes requires departure from basic theory.
Ex.) In the public utility industry, non-current
assets are reported first on the balance sheet to
highlight the industry’s capital-intensive nature.
Constraints
4. Conservatism – when in doubt, choose the
solution that will be least likely to overstate
assets and income.
When in doubt, or when subjective estimates
are necessary, refrain from overstatement of net
income and net assets.
Review
According to the FASB conceptual framework, the
objectives of financial reporting for business
enterprises are based on?
a.
Generally accepted accounting principles
b. Reporting on management’s stewardship.
c.
The need for conservatism.
d.
The needs of the users of the information.
The current proposed converged framework adopts the
FASB’s focus on investors and creditors.
LO 3

The existing conceptual frameworks underlying U.S. GAAP and iGAAP
are very similar.

The converged framework should be a single document, unlike the two
conceptual frameworks that presently exist.

The IASB framework makes two assumptions. One assumption is that
financial statements are prepared on an accrual basis; the other is
that the reporting entity is a going concern.

There is some agreement that the role of financial reporting is to
assist users in decision making. However, others note that another
objective is to provide information on management’s performance,
often referred to as stewardship.