Conceptual Framework For Financial Reporting

Chapter
2-1
Chapter 2
Conceptual Framework For
Financial Reporting

Chapter
2-2
Like a constitution.
Establishes concepts that underlie financial reporting
A conceptual framework is a coherent system of
concepts that flow from an objective.
The objective identifies the purpose of financial
reporting.
Conceptual Framework
Chapter
2-3
Conceptual Framework (Cont.)
provides guidance on
1. identifying the boundaries of financial reporting;
2. selecting the transactions, other events, and
circumstances to be represented;
3. how they should be recognized and measured;
4. how they should be summarized and reported.

Chapter
2-4
To develop a coherent set of standards and rules,
else standard-setting based on personal conceptual
frameworks will lead to different conclusions about
identical or similar issues
To solve new and emerging practical problems
The Need for a Conceptual Framework
Chapter
2-5
Development of a Conceptual Framework

Both the IASB and the FASB have a conceptual
framework.

The IASBs conceptual framework is described in the
document, Framework for Preparation and Presentation of
Financial Statements.

The FASBs conceptual framework is developed in a
series of concepts statements, which is generally referred
to as the Conceptual Framework.

The IASB and the FASB are now working on a joint
project to develop an improved common conceptual
framework that provides a sound foundation for developing
future accounting standards.
Chapter
2-6
The FASB has issued six Statements of Financial
Accounting Concepts (SFAC) for business enterprises.
SFAC No.1 - Objectives of Financial Reporting
SFAC No.2 - Qualitative Characteristics of Accounting Information
SFAC No.3 - Elements of Financial Statements (superceded by
SFAC No. 6)
SFAC No.5 - Recognition and Measurement in Financial Statements
SFAC No.6 - Elements of Financial Statements (replaces SFAC No. 3)
SFAC No.7 - Using Cash Flow Information and Present Value in
Accounting Measurements
Development of a Conceptual Framework
Chapter
2-7
The Framework is comprised of three levels:
First Level = Basic Objectives
Second Level = Qualitative Characteristics and
Basic Elements
Third Level = Recognition and Measurement
Concepts.
Overview of the Conceptual Framework
Chapter
2-8
ASSUMPTIONS
1. Economic entity
2. Going concern
3. Monetary unit
4. Periodicity
PRINCIPLES
1. Measurement
2. Revenue recognition
3. Expense recognition
4. Full disclosure
CONSTRAINTS
1. Cost-benefit
2. Materiality
3. Industry practice
4. Conservatism
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
ELEMENTS
Assets, Liabilities, and Equity
Investments by owners
Distribution to owners
Comprehensive income
Revenues and Expenses
Gains and Losses
Illustration 2-7
Conceptual Framework
for Financial Reporting
First level
Second level
Third
level
QUALITATIVE
CHARACTERISTICS
Relevance
Reliability
Comparability
Consistency
Chapter
2-9
First Level: Basic Objective
The objective of financial reporting is the foundation of
the Framework.
Financial reporting should provide information that:

useful to present and potential equity investors, lenders,
and other creditors in making decisions as capital providers

helps investors (both Present and Prospective) and
creditors in assessing the amounts, timing, and uncertainty
of prospective cash receipts

portrays the economic resources of a firm, the claims to
those resources and the changes in them
Chapter
2-10
Qualitative Characteristics
The IASB identified the qualitative characteristics
of accounting information that distinguish better
(more useful) information from inferior (less useful)
information for decision-making purposes.
IASB identified certain constraints (cost and
materiality) as part of the conceptual framework
Second Level: Fundamental Concepts
Chapter
2-11
Understandability
Is the quality of information that lets reasonably
informed users see its significance.
Understandability is enhanced when information is
classified, characterized and presented clearly and
concisely.
Second Level: Fundamental Concepts
Chapter
2-12
Primary Qualities:
Relevance capable of making a difference in a
decision.
Predictive value
Feedback value
Timeliness
Reliability
Verifiable
Faithful Representation
Neutral - free of error and bias
Second Level: Qualitative Characteristics

Chapter
2-13
Secondary Qualities (Enhancing Qualities)
Comparability Information that is measured and
reported in a similar manner for different
companies is considered comparable.
Consistency - When a company applies the same
accounting treatment to similar events from period
to period.
Second Level: Qualitative Characteristics
Chapter
2-14
Revenue
Expenses
Investment by owners
Distribution to owners
Comprehensive income
Gains
Losses
Concepts Statement No. 6 defines ten interrelated
elements that relate to measuring the performance and
financial status of a business enterprise.
Assets
Liabilities
Equity
Moment in Time Period of Time
Second Level: Basic Elements

Chapter
2-15
Economic Entity company keeps its activity
separate from its owners and other businesses.
Going Concern - company to last long enough to fulfill
objectives and commitments.
Monetary Unit - money is the common denominator.
Periodicity - company can divide its economic
activities into artificial time periods. i.e monthly,
quarterly, and yearly
Third Level: Assumptions
Chapter
2-16
Measurement The most commonly used measurements are
based on historical cost and fair value.
Issues:
Historical cost provides a reliable benchmark for measuring
historical trends. IFRS requires that the companies report
many assets and liabilities on the basis of acquisition price.
Fair value information may be more useful for certain types
of assets and liabilities and in certain industries.
Recently the FASB has taken the step of giving companies
the option to use fair value as the basis for measurement of
financial assets and financial liabilities. Also IASB has taken
steps to give the options to use fair value.
Reporting of fair value information is increasing. Although it
increases subjectivity when FV information is not available. .
Third Level: Principles
Chapter
2-17
Revenue Recognition Principle - generally occurs (1)
when realized or realizable and (2) when earned.
Exceptions: Timing of Revenue Recognition
Chapter
2-18
Full Disclosure providing information that is of
sufficient importance to influence the judgment and
decisions of an informed user.
Provided through:
Financial Statements
Notes to the Financial Statements
Supplementary information
Chapter
2-19
Cost Benefit the cost of providing the information
must be weighed against the benefits that can be
derived from using it.
Materiality - an item is material if its inclusion or
omission would influence or change the judgment of
a reasonable person.
Industry Practice - the peculiar nature of some
industries and business concerns sometimes requires
departure from basic accounting theory.
Conservatism when in doubt, choose the solution
that will be least likely to overstate assets and
income.
Third Level: Constraints
Chapter
2-20
The existing conceptual frameworks underlying U.S. GAAP and IFRS
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 managements performance,
often referred to as stewardship.

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