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CHAPTER 2
Chapter 2: The
Conceptual
Framework
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Structure of Accounting Theory
Formal Approach
Accounting theory provides a logical
framework for accounting practice.
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Structure of Accounting Theory
Formal Approach
Accounting theory provides a logical
framework for accounting practice.
ASSUMPTIONS
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Structure of Accounting Theory
Formal Approach
Accounting theory provides a logical
framework for accounting practice.
PRINCIPLES
ASSUMPTIONS
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Structure of Accounting Theory
Formal Approach
Accounting theory provides a logical
framework for accounting practice.
RULES
PRINCIPLES
ASSUMPTIONS
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The Conceptual Framework
elements
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Goals
Assumptions
Principles
Information characteristics
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“Objectives of Financial Reporting By Business
Enterprises”
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Report on enterprise resources, claims
against resources and changes in them
Report economic resources, obligations
and owners equity
Report enterprise performance and
earnings
Evaluate liquidity, solvency, and flow of
funds
Explain and interpret financial information
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Assumptions
1-Business Entity “Idea”
Each business has an
identity separate from its
owners.
l The business is the
accounting entity.
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Financial statements report
only the activities, resources,
and obligations of that
business.
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2-Going-Concern
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In the absence of evidence to the
contrary, we assume that a
business will continue to exist
indefinitely.
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For example, a company is more
likely to acquire long-term assets if
it can assume that the company will
continue to exist indefinitely.
It is fundamental to the matching
principle.
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3-MONEY MEASUREMENT
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Business entities measure economic
events and transactions in monetary
units.
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In the United States, the unit of
measurement is the dollar. In Jordan the
unit of measurement is JD
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Stable Dollar or
Stable Monetary Unit
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Assumes that the dollar maintains a
relatively stable value.
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In countries with high inflation, this
assumption may not be valid.
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Stable Dollar or
Stable Monetary Unit
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Assumes that the dollar maintains a
relatively stable value.
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In countries with high inflation, this
assumption may not be valid.
Accountants do not adjust the
accounts for the changing value of
the dollar (i.e., inflation)
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4-Periodicity
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Continuous business activity is divided
into arbitrary time periods as exemplified
by this time line.
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Business activity is best reported in
annual, quarterly or monthly periods.
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Main principles
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Substance Over Form
The substance of a transaction or
economic event is more important
than its legal form.
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principles
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Substance Over Form
The substance of a transaction or
economic event is more important
than its legal form.
e.g., next semester, we will
study that even though parent
and subsidiary companies are
legally separate entities, GAAP
says that a set of consolidated
financial statements must be
prepared as if they were one
company, i.e., one economic
entity.
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Other Major Principles/Ideas
Historical Cost
Matching
Revenue Recognition
Expense Recognition
Gain and Loss
Recognition
Full Disclosure
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Major Principles/Ideas
Historical Cost
Matching
Revenue Recognition
Expense Recognition
Gain and Loss
Recognition
Full Disclosure
All transactions
are recorded at
their historical
cost at the time of
the transaction.
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Major Principles/Ideas
Cost
Matching
Revenue Recognition
Expense Recognition
Gain and Loss
Recognition
Full Disclosure
The most
important
principle. It
provides the basis
for accrual
accounting.
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Major Principles/Ideas
Exchange-Price or
Historical Cost
Matching
Revenue Recognition
Expense Recognition
Gain and Loss
Recognition
Full Disclosure
Revenues are
recorded when
they are earned
(i.e., realized).
When does this
happen?
When title passes.
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Exceptions to
Revenue Recognition Principle
Cash basis of revenue recognition
Installment basis of revenue recognition
(Need only know concept, not how to apply)
Percentage-of-completion basis of
revenue recognition
Revenue recognition at completion of
production
(Need only know concept, not how to apply)
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181
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Major Principles/Ideas
Historical Cost
Matching
Revenue Recognition
Expense Recognition
Gain and Loss
Recognition
Full Disclosure
Expenses should
be recorded as
they are incurred
in the process of
earning revenues.
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Major Principles/Ideas
Historical Cost
Matching
Revenue Recognition
Expense Recognition
Gain and Loss
Recognition
Full Disclosure
The rules are
different for
recognition of
gains and losses.
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Gain and Loss Recognition
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Gains are recognized/recorded at the
time they are realized.
For example, an increase in the value of land
cannot be recognized as a gain until the land is
actually sold.
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Gain and Loss Recognition
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Gains are recognized/recorded at the
time they are realized.
For example, an increase in the value of land
cannot be recognized as a gain until the land is
actually sold.
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Losses are recognized when they
become apparent.
For example, a decrease in the value of
inventory would be recognized as a loss when
it becomes apparent.
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Major Principles/Ideas
Matching
Revenue Recognition
Expense Recognition
Gain and Loss
Recognition
Full Disclosure
Disclose in the
financial
statements or
related notes, all
information
important enough
to influence a
stakeholder.
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Cost-Benefit Consideration
Optional information should
be included in the primary
financial statements only if
the benefits of providing it
exceed the costs.
For example, providing a listing of
every sales transaction may be
interesting, but the cost of providing
that information to every shareholder
might bankrupt the company.
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8-Materiality
An item is material if knowledge of the
item would affect the decision of an
informed user, therefore, this is a
somewhat nebulous concept.
l Material items must be reported.
l An item can be material either in amount
or in nature.
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Materiality in amount is relative to the size
of the amounts on a company’s fin. stmts.
(e.g. $50,000,000 may not be material …)
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9-Conservatism
Transactions should
be recorded so that
net assets and net
income are not
overstated.
Anticipate losses, but
do not anticipate
gains.
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“Qualitative Characteristics of
Accounting Information
Addresses the question: What
makes accounting information
useful?
l Develops a Hierarchy of Accounting
Qualities
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A Hierarchy of Accounting Qualities
Users of
Accounting
Information
Decision makers
and their characteristics
(for example, understanding
of prior knowledge
Pervasive
Constraint
Benefits > Costs
Understandability
User-specific
qualities
Decision Usefulness
Primary
Decision-specific
qualities
Relevance
Reliability
Timelines
Ingredients of
primary qualities
Secondary and
interactive qualities
Threshold for
recognition
Predictive
value
Verifiability
Feedback
value
Representational
faithfulness
Neutrality
Comparability
(including Consistency
Materiality
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The Conceptual Framework
of the international accounting standards
committee ( IASC)
It Was formed in 1973 to develop worldwide accounting standards it
was an independent private – sector body , whose objectives was to
achieve uniformity in accounting principle that are used for
worldwide financial reporting
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The original board members of IASC were the accounting bodies
of 9 countries :Australia, Canada, France, Japan, Mexico,
Germany Netherlands, United Kingdom, United States
Objectives IASC 1973-2000
1.
formulate and publish in the public interest accounting standards to
be observed in the presentation of financial statements and promote
their worldwide acceptance and observance
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2-work generally for the improvement and harmonization of
regulations, accounting standards and procedures …
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From IASC to IASB
IASC Board
IASB
Board
volunteers, constituencies
independent
approve IAS
Consultative Group
Advisory Council
Advisory Council
Oversight , funding
full-time,
approve IFRS
Standards
Trustees
appoint Board
oversight funding
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IASC
The original board members of IASC were
the accounting bodies of 9 countries
1)
Australia
2)
Canada
3)
France
4)
Japan
5)
Mexico
6)
Netherlands
7)
United Kingdom
8)
United States
9)
Germany
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Objectives IASC 1973-2005
formulate and publish in the public
interest accounting standards to be
observed in the presentation of
financial statements and promote
their worldwide acceptance and
observance
u work generally for the improvement
and harmonization of regulations,
accounting standards and
procedures …
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Overview of the Restructured IASB
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Components of the new structure:
International Accounting Standards Board (IASB) – has sole responsibility
for establishing International Financial Reporting Standards (IFRSs).
IFRS Foundation (IFRSF) – oversees the work of the IASB, the structure,
and strategy, and has fundraising responsibility.
IASCF Monitoring Board – oversees the IFRSF Trustees, participates in the
Trustee nomination process, and approves appointments to the Trustees.
IFRS Interpretations Committee (IFRIC) – develops interpretations for
approval by the IASB.
IFRS Advisory Council (SAC) – advises the IASB and the IFRSF.
Working Groups – expert task forces for individual agenda projects.
*The Trustees announced that these name changes will be implemented as
soon as practicable.
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IFRS Due Process
Due process steps. Formal due process for projects normally, but not necessarily, involves the following
steps.
study national accounting requirements and practice and exchange views about the issues with national
standard-setters;
IFRSF
consults the Standards Advisory Council about the advisability of adding the topic to the IASB's agenda;
form an advisory group (generally called a 'working group') to advise the IASB and its staff on the project;
IASB
publish for public comment a discussion document;
publish for public comment an exposure draft approved by vote of at least nine IASB members, including any
dissenting opinions held by IASB members (in exposure drafts, dissenting opinions are referred to as
'alternative views')
consider all comments received within the comment period on discussion documents and exposure drafts
consider the desirability of holding a public hearing and the desirability of conducting field tests
IFRSC
Issue a final IFRS by at least votes of at least nine IASB members and include in the published standard any
dissenting opinions;* and
publish within a standard a basis for conclusions, explaining, among other things, the steps in the IASB's
due process and how the IASB dealt with public comments on the exposure draft.
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Use of IAS/IFRS
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IAS as national standards
u Croatia, Cyprus, Jordan, Kuwait, Romania, Nepal
Serbia, peru
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IAS as basis for national standards
u China, Denmark, Switzerland,
Harmonisation/convergence projects
u Australia, USA, Japan, Hong Kong, South Africa,
Sweden, UK, Egypt