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Chapter 1
Conceptual Framework Conceptual Framework Underlying Financial AccountingUnderlying Financial Accounting
1. Explain the FASB conceptual framework.
2. Understand the relationship among the objectives of financial reporting.
3. Identify the general objective of financial reporting.
4. Describe the three specific objectives of financial reporting.
ContinuedContinuedContinuedContinued
5. Discuss the types of useful information for investment and credit decision making.
6. Explain the qualities of useful accounting information.
7. Understand the accounting assumptions and conventions that influence GAAP.
8. Define the elements of financial statements.
How do we determine the amount of
information to
supply in general-purpose financial statements?
In what format? Under what assumptions, principles, and
constraints?
The FASB’s Conceptual FrameworkThe FASB’s Conceptual FrameworkThe FASB’s Conceptual FrameworkThe 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.
The FASB’s Conceptual FrameworkThe FASB’s Conceptual FrameworkThe FASB’s Conceptual FrameworkThe 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.
The FASB’s Conceptual FrameworkThe FASB’s Conceptual FrameworkThe FASB’s Conceptual FrameworkThe 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.
The FASB’s Conceptual FrameworkThe FASB’s Conceptual FrameworkThe FASB’s Conceptual FrameworkThe FASB’s Conceptual Framework
To develop a conceptual
framework of accounting theory.
To establish standards (GAAP)
for financial accounting practices.
General ObjectiveProvide information that is
useful to present and potential investors, creditors, and other
users in making rational investment, credit, and similar
decisions.
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
SFAC No. 1SFAC No. 1SFAC No. 1SFAC No. 1
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.
SFAC No. 1SFAC No. 1Financial Reporting ObjectivesFinancial Reporting Objectives
SFAC No. 1SFAC No. 1Financial Reporting ObjectivesFinancial Reporting Objectives
Financial Reports
Return on Investment
Risk
Financial Flexibility
Liquidity
Operating Capability
•Buy•Hold• Sell
• Extend Credit
• Continue Credit
• Deny Credit
Communication Documents
Types of Useful Information External Decision Making
Primary Decision-Specific QualitiesPrimary Decision-Specific Qualities
RelevanceRelevance ReliabilityReliability
Accounting Information
Benefits>CostsBenefits>Costs
UnderstandabilityUnderstandability
Decision Usefulness
Pervasive Pervasive ConstraintConstraint
Pervasive Pervasive ConstraintConstraint
ContinuedContinuedContinuedContinued
User-User-Specific Specific QualityQuality
User-User-Specific Specific QualityQuality
Overall Overall QualityQuality
Overall Overall QualityQuality
Ingredients of Primary QualitiesIngredients of Primary Qualities
RelevanceRelevance ReliabilityReliability
Predictive Value
Predictive Value
Feedback Value
Timeli-ness
Verifi-ability
Representa-tional
faithfulness
Neu-trality
Secondary and
Interactive Qualities
MaterialityMateriality
Comparability (including Consistency
Threshold for
Recognition
Threshold for
Recognition
Accounting information is relevant if it can make a difference in a decision.
Accounting information is relevant if it can make a difference in a decision.
SFAC No. 2SFAC No. 2SFAC No. 2SFAC No. 2
Qualitative Characteristics of Accounting Information
Primary Quality . . . Relevance.1. Timeliness
2. Predictive value
3. Feedback value
SFAC No. 2SFAC No. 2SFAC No. 2SFAC No. 2
Accounting information is reliable when it is reasonably free from error and bias, and faithfully represents what it
is intended to represent.
Accounting information is reliable when it is reasonably free from error and bias, and faithfully represents what it
is intended to represent.
SFAC No. 2SFAC No. 2SFAC No. 2SFAC No. 2
Qualitative Characteristics of Accounting Information
Primary Quality . . . Reliability.1. Representational faithfulness
2. Verifiability
3. Neutrality
SFAC No. 2SFAC No. 2SFAC No. 2SFAC No. 2
Qualitative Characteristics of Accounting Information
Secondary QualitiesComparability and Consistency
SFAC No. 2SFAC No. 2SFAC No. 2SFAC No. 2
Comparability of accounting information enables users to
identify and explain similarities and differences between two or
more sets of economic facts.
Comparability of accounting information enables users to
identify and explain similarities and differences between two or
more sets of economic facts.
SFAC No. 3SFAC No. 3SFAC No. 3SFAC 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
SFAC No. 3SFAC No. 3SFAC No. 3SFAC No. 3
Recognition is the process of formally recording and reporting an item in the financial statements of a
company.
Recognition is the process of formally recording and reporting an item in the financial statements of a
company.
SFAC No. 3SFAC No. 3SFAC No. 3SFAC No. 3
Definition
Measurability
Relevance
Reliability
SFAC No. 3SFAC No. 3Recognition CriteriaRecognition Criteria
SFAC No. 3SFAC No. 3Recognition CriteriaRecognition Criteria
Continued use of different attributes (historical cost, current cost, market value, etc.).
All monetary measurement based on nominal units of money.
SFAC No. 4SFAC No. 4Measurement CriteriaMeasurement Criteria
SFAC No. 4SFAC No. 4Measurement CriteriaMeasurement Criteria
Separate entity assumption
Continuity assumption
Unit-of-measure assumption
Time period assumption
SFAC No. 4SFAC No. 4Environmental AssumptionsEnvironmental Assumptions
SFAC No. 4SFAC No. 4Environmental AssumptionsEnvironmental Assumptions
EntityEntity
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.
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.
SFAC No. 4SFAC No. 4Environmental AssumptionsEnvironmental Assumptions
SFAC No. 4SFAC No. 4Environmental AssumptionsEnvironmental Assumptions
ContinuityContinuity
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.
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.
SFAC No. 4SFAC No. 4Environmental AssumptionsEnvironmental Assumptions
SFAC No. 4SFAC No. 4Environmental AssumptionsEnvironmental Assumptions
Period of TimePeriod 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.
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.
SFAC No. 4SFAC No. 4Environmental AssumptionsEnvironmental Assumptions
SFAC No. 4SFAC No. 4Environmental AssumptionsEnvironmental Assumptions
Monetary UnitMonetary 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.
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.
The FASB encourages companies to prepare supplemental disclosures about the impact of
changing prices.
SFAC No. 4SFAC No. 4Environmental AssumptionsEnvironmental Assumptions
SFAC No. 4SFAC No. 4Environmental AssumptionsEnvironmental Assumptions
Cost principle
Realization principle
Matching concept
Full disclosure principle
SFAC No. 4SFAC No. 4Implementation PrinciplesImplementation Principles
SFAC No. 4SFAC No. 4Implementation PrinciplesImplementation Principles
Market Value
$13,500
Market Value
$13,500Cost
$16,000
Cost$16,000
Replacement Cost
$13,000
Replacement Cost
$13,000
Historical CostHistorical Cost
Usually, the exchange price is retained in the accounting records as the value of an item until it is removed from the records.
Usually, the exchange price is retained in the accounting records as the value of an item until it is removed from the records.
SFAC No. 4SFAC No. 4Implementation PrinciplesImplementation Principles
SFAC No. 4SFAC No. 4Implementation PrinciplesImplementation Principles
Historical CostHistorical Cost
Which amount Which amount should be used?should be used?Which amount Which amount should be used?should be used?
Cost$16,000
Cost$16,000
SFAC No.4SFAC No.4Implementation PrinciplesImplementation Principles
SFAC No.4SFAC No.4Implementation PrinciplesImplementation Principles
Realization is the process of converting noncash resources and rights into cash or rights to cash.
Realization is the process of converting noncash resources and rights into cash or rights to cash.
SFAC No. 5SFAC No. 5Implementation PrinciplesImplementation Principles
SFAC No. 5SFAC No. 5Implementation PrinciplesImplementation Principles
Realization principle: Two conditions must be met if therevenue principle is to be satisfied.
ReasonableAssurance of
Collection
SubstantialCompletion of
Earning Process
SFAC No. 5SFAC No. 5Implementation PrinciplesImplementation Principles
SFAC No. 5SFAC No. 5Implementation PrinciplesImplementation Principles
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.
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.
Matching PincipleMatching Pinciple
SFAC No. 5SFAC No. 5Implementation PrinciplesImplementation Principles
SFAC No. 5SFAC No. 5Implementation PrinciplesImplementation Principles
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.
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.
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.
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.
Matching PrincipleMatching Principle
SFAC No. 5SFAC No. 5Implementation PrinciplesImplementation Principles
SFAC No. 5SFAC No. 5Implementation PrinciplesImplementation Principles
•Parenthetical Comments
•Disclosure Notes
•Supplemental Financial Statements
•Parenthetical Comments
•Disclosure Notes
•Supplemental Financial Statements
Full Disclosure PrincipleFull Disclosure Principle
SFAC No. 5SFAC No. 5Implementation PrinciplesImplementation Principles
SFAC No. 5SFAC No. 5Implementation PrinciplesImplementation Principles
Cost-benefit constraint
Materiality constraint
Conservatism constraint
Industrial peculiarities
SFAC No. 5SFAC No. 5Implementation ConstraintsImplementation Constraints
SFAC No. 5SFAC No. 5Implementation ConstraintsImplementation Constraints
Are benefits greater
than costs?
Cost-benefit Constraint
SFAC No. 5SFAC No. 5Implementation ConstraintsImplementation Constraints
SFAC No. 5SFAC No. 5Implementation ConstraintsImplementation Constraints
The nature of the item. The relative size rather
than absolute size of an item.
The nature of the item. The relative size rather
than absolute size of an item.
Materiality
SFAC No. 5SFAC No. 5Implementation ConstraintsImplementation Constraints
SFAC No. 5SFAC No. 5Implementation ConstraintsImplementation Constraints
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.
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.
Conservatism
SFAC No. 5SFAC No. 5Implementation ConstraintsImplementation Constraints
SFAC No. 5SFAC No. 5Implementation ConstraintsImplementation Constraints
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)
General-Purpose Financial StatementsGeneral-Purpose Financial StatementsGeneral-Purpose Financial StatementsGeneral-Purpose Financial Statements
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
SFAC No. 6SFAC No. 6SFAC No. 6SFAC No. 6
A balance sheet is a financial statement that
summarizes the financial position of a company on
a particular date.
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.
It also is called a statement of
financial position.
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 a balance sheet:
An income statement is a financial statement that
summarizes the results of a company’s operations.
An income statement is a financial statement that
summarizes the results of a company’s operations.
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.
ContinuedContinuedContinuedContinued
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.
ContinuedContinuedContinuedContinued
The elements of the income statement are:
Gains 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.
ContinuedContinuedContinuedContinued
The elements of the income statement are:
Losses 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.
The elements of the income statement are:
Revenues increase the equity of the
company
Expenses decrease the equity of the
company
A statement of changes in equity summarizes the changes in a company’s
equity for a period.
A statement of changes in equity summarizes the changes in a company’s
equity for a period.
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.
A statement of changes in equity contains two elements:
Comprehensive income includes all changes in equity during a
period except those resulting form investments by owners and
distributions to owners.
Comprehensive income includes all changes in equity during a
period except those resulting form investments by owners and
distributions to owners.
1. Financial and nonfinancial data.
2. Management’s analysis of the financial and nonfinancial data.
3. Forward-looking information.
4. Information about management and shareholders.
5. Background about the company.
Framework of the Model
Chapter1
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