Conceptual Framework Conceptual Framework

Elements

Recognition & Measurement ConceptsAssumptions, Principles & Concepts

Financial Statements / Financial Reporting

Objectives

Qualitative Characteristics

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Objectives of Financial Reporting by Objectives of Financial Reporting by Business Enterprises: User PerspectiveBusiness Enterprises: User Perspective

Financial reporting should provide:Financial reporting should provide:

(1) information useful in investment & credit decisions(1) information useful in investment & credit decisions

(2) information useful in assessing cash flow prospect (2) information useful in assessing cash flow prospect (amount, timing & uncertainty), &(amount, timing & uncertainty), &

(3) information about enterprise resources, claims to (3) information about enterprise resources, claims to those resources, & changes therin.those resources, & changes therin.

*** ... individuals who have a reasonable understanding *** ... individuals who have a reasonable understanding of business & economic activities & are willing to of business & economic activities & are willing to study the information with reasonable diligence.study the information with reasonable diligence.

SFAC 1

Qualitative CharacteristicsQualitative CharacteristicsPrimary Qualities:Primary Qualities:(1) Relevance(1) Relevance

(a) Predictive value,(a) Predictive value,(b) Feedback value &(b) Feedback value &(c) Timeliness(c) Timeliness

(2) Reliability(2) Reliability(a) Verifiability(a) Verifiability(b) Representational Faithfulness(b) Representational Faithfulness(c) Neutrality(c) Neutrality

Secondary Qualities:Secondary Qualities:(1) Comparability (1) Comparability (across firms)(across firms)(2) Consistency (2) Consistency (over time)(over time)

SFAC 2

Elements of Financial StatementsElements of Financial Statements

• AssetsAssets

• LiabilitiesLiabilities

• EquityEquity

• Investments by Investments by OwnersOwners

• Distributions to Distributions to OwnersOwners

• Comprehensive Comprehensive Income Income

• RevenueRevenue

• ExpensesExpenses

• GainsGains

• LossesLosses

SFAC 6

Recognition Recognition & &

Measurement Measurement ConceptsConcepts

• AssumptionsAssumptions– Economic EntityEconomic Entity– Going ConcernGoing Concern– Monetary UnitMonetary Unit– PeriodocityPeriodocity

• PrinciplesPrinciples– Historical CostHistorical Cost– Revenue RecognitionRevenue Recognition– MatchingMatching– Full disclosureFull disclosure

• ConstraintsConstraints– Cost-BenefitsCost-Benefits– MaterialityMateriality– Industry PracticeIndustry Practice– ConservatismConservatism

Economic Entity:Economic Entity: The business or economic entity exists separate The business or economic entity exists separate & distinct from its owners, employees, suppliers & customers. & distinct from its owners, employees, suppliers & customers. This assumption defines This assumption defines accountingaccounting boundaries, but not legal boundaries, but not legal boundaries.boundaries.

Going Concern:Going Concern: General purpose accounting reports are General purpose accounting reports are constructed under the assumption that the business enterprise will constructed under the assumption that the business enterprise will continue in business for the foreseeable future. The current continue in business for the foreseeable future. The current relevance of the historical cost principle is based on the going-relevance of the historical cost principle is based on the going-concern assumption.concern assumption.

Monetary Unit:Monetary Unit: Economic activity of an entity are measured and Economic activity of an entity are measured and reported in the U.S. dollar. This assumes that the dollar has a reported in the U.S. dollar. This assumes that the dollar has a reasonably constant value over time in terms of purchasing power. reasonably constant value over time in terms of purchasing power. This assumption ignores inflation. This assumption ignores inflation.

Periodocity:Periodocity: Assumes that the economic life of a business can be Assumes that the economic life of a business can be divided into discrete time periods and that financial reports from divided into discrete time periods and that financial reports from each period are interpretable.each period are interpretable.

Accounting Assumptions:Accounting Assumptions:

Acquisition cost is the most objective and Acquisition cost is the most objective and verifiable basis upon which to account for verifiable basis upon which to account for assets and liabilities. That is, it is reliable.assets and liabilities. That is, it is reliable.

5 methods to measure assets & liabilities5 methods to measure assets & liabilities::– Historical costHistorical cost

– Current costCurrent cost

– Current market valueCurrent market value

– Net realizable (settlement) valueNet realizable (settlement) value

– Present (discounted) valuePresent (discounted) value

Historical Cost PrincipleHistorical Cost Principle

Recognize Revenue when:Recognize Revenue when:

(a) realized or realizable & (a) realized or realizable &

(b) earned…………………….on the date of sale(b) earned…………………….on the date of sale

exceptions:exceptions:

(a) during production ... if the production process is long (a) during production ... if the production process is long … … Ex: long-term construction contractEx: long-term construction contract

(b) end of production … (b) end of production … if selling price & amount is certain if selling price & amount is certain

…… ex: mining of certain minerals ex: mining of certain minerals

(c) receipt of cash … if the amount to be collected is(c) receipt of cash … if the amount to be collected is

uncertainuncertain

Revenue Recognition PrincipleRevenue Recognition Principle

RecognitionRecognition

Revenue…………when realized or realizable & earnedRevenue…………when realized or realizable & earned

Gains ……………when realized or realizableGains ……………when realized or realizable

Expenses ….……when economic benefits are consumedExpenses ….……when economic benefits are consumed

in revenue-earning activities or whenin revenue-earning activities or when

future economic benefits are reduced or future economic benefits are reduced or

eliminatedeliminated

Losses …………..when future economic benefits are reducedLosses …………..when future economic benefits are reduced

or eliminatedor eliminated

SFAC 5

Expenses are matched to the revenue Expenses are matched to the revenue generated in that accounting periodgenerated in that accounting period

““let the expenses follow the revenues”let the expenses follow the revenues”

Matching PrincipleMatching Principle

Financial statements should include sufficient Financial statements should include sufficient information to permit the knowledgeable information to permit the knowledgeable

reader to make an informed judgment about reader to make an informed judgment about the financial condition of the enterprise.the financial condition of the enterprise.

trade-offs:trade-offs:

--sufficient detail to make a differencesufficient detail to make a difference

-presented in a condensed form for -presented in a condensed form for

understandability & to avoid information overloadunderstandability & to avoid information overload

Full Disclosure PrincipleFull Disclosure Principle

Cost-Benefit:Cost-Benefit: The cost of providing the information The cost of providing the information should not exceed the benefits that can be derived should not exceed the benefits that can be derived from the information.from the information.

MaterialityMateriality: An item is material if its inclusion or : An item is material if its inclusion or omission would influence or change the judgment of a omission would influence or change the judgment of a reasonable man. Materiality is based on relative size reasonable man. Materiality is based on relative size & importance.& importance.

Industry Practice:Industry Practice: The unique nature of some The unique nature of some industries and business concerns sometimes (rarely) industries and business concerns sometimes (rarely) requires departure from basic theory.requires departure from basic theory.

Conservatism:Conservatism: Never overstate assets or income. Never overstate assets or income.

Constraints:Constraints:

Financial Statements show:Financial Statements show:

• Statement of Financial PositionStatement of Financial Position

• EarningsEarnings• Comprehensive Earnings Comprehensive Earnings (earnings adjusted (earnings adjusted

for the cumulative adjustment or other nonowner for the cumulative adjustment or other nonowner changes in equity foreign currency translation)changes in equity foreign currency translation)

• Cash FlowsCash Flows

• Transactions with OwnersTransactions with Owners

Decision Makers

Materiality Materiality

A Hierarchy of Accounting QualitiesA Hierarchy of Accounting Qualities

SFAC 2

Users ofUsers ofAccounting Accounting InformationInformation

PervasivePervasiveContraintContraint

User SpecificUser SpecificQualitiesQualities

Primary Primary QualitiesQualities

Primary Primary QualitiesQualities

Secondary Secondary QualitiesQualities

Threshold forRecognition

Benefits > Costs

Relevance Reliability

Predictive Feedback Time- Verifi- Neutral- Representational Predictive Feedback Time- Verifi- Neutral- Representational Value Value liness ability ity Faithfulness Value Value liness ability ity Faithfulness

ComparabilityComparability Consistency Consistency

UnderstandabilityUnderstandability

Decision UsefulnessDecision Usefulness