Chapter 2
Conceptual Framework
For Financial Reporting
The conceptual accounting framework is
a foundation and guideline for the
establishment of accounting standards.
FASB was the first promulgating board to
develop a formal conceptual framework
through the issue of Statements of
Financial Accounting Concepts
These SFACs are not GAAP; rather they
are guidelines to the development of
Development of
Conceptual Framework
SFAC 1, 1978: Objectives of Financial
Reporting by Business Enterprises*
SFAC 2, 1980: Qualitative Characteristics of
Accounting Information*
SFAC 3, 1980: Elements of Financial
Statements of Business Enterprises*
SFAC 5, 1984: Recognition and Measurement
in Financial Statements of Business
SFAC 6,1985: Elements of Financial
Statements (replacement of SFAC 3)
Development of
Conceptual Framework
SFAC 7, 2000: Using Cash Flow Information and
Present Value in Accounting Measurements
SFAC 8, 2010: Conceptual Framework for
Financial Reporting
Chapter 1: The Objective of General Purpose
Financial reporting
Chapter 3: Qualitative Characteristics of
Useful Financial Information
Coordinating with IASB; more chapters to come.
Overview of the Conceptual Framework see p. 65 of text.
Level 1: Objective of Financial Reporting
Level 2: Qualitative Characteristics
Elements of Financial Statements
Level 3: Recognition, Measurement and
Disclosure Concepts
Objective of Financial Reporting
SFAC 8, Chapter 1:
“The objective of general-purpose financial
reporting is to provide financial
information about the reporting entity that
is useful to present and potential equity
investors, lenders, and other creditors in
making decisions about providing
resources to the entity.”
Fundamental Quality - Relevance
Relevance – makes a difference in decisions
of users of financial information.
Predictive Value – useful in making
estimations about the future.
Confirmatory Value – offers verification of
prior estimations.
Materiality – requires appropriate reporting
to allow the users to incorporate into their
decision process (immaterial activities may
be reported in non-GAAP ways).
Fundamental Quality –Faithful
Faithful Representation – the numbers
and descriptions match what they are
Completeness – all information that is
necessary for faithful representation is
Neutrality – free from bias.
Free from Error – an accurate
representation of the information.
Enhancing Qualities
Comparability – company to company,
information is calculated and reported in a
similar manner.
Consistency – for a particular company, year to
year, the same techniques and
measurements are used, or the change in
methods is disclosed.
Verifiability –when independent measurers,
using the same methods, obtain similar
Timeliness – reporting information in a
sufficiently short time period, so that the
information is still useful.
Understandability – clear presentation that
allows for proper use of the information.
From SFAC 6 –
See page 55 for elements.
Note “Comprehensive Income” is currently
being incorporated into financial
Basic definition:
Net Income (Income Statement)
+ Other Comprehensive Income (St. of SE)
= Comprehensive Income
Recognition and Measurement
Basic Assumptions:
– Economic Entity
– Going Concern
– Monetary Unit
– Periodicity
Basic Principles:
– Measurement
– Revenue Recognition
– Expense Recognition
– Full Disclosure
– Cost
– Industry Practices
Economic Entity Assumption
A company is assumed to be a separate
economic entity that can be identified
and measured.
 This concept helps determine the scope
of financial statements.
 Many businesses own subsidiaries, and
the subsidiaries are separate legal
entities from the parent, though the
combined reporting would represent the
economic entity.
Going Concern Assumption
The life of an economic entity is
assumed to be indefinite.
 Assets, defined as having future
economic benefit, require this
 Allocation of costs to future periods is
supported by the going concern
Monetary Unit Assumption
The monetary unit assumption is that
money is an appropriate basis for
accounting measurement and analysis,
 The monetary unit assumption also
implies that the dollar (in the US) is a
stable unit of measure, and that the
purchasing power a dollar remains
Periodicity Assumption
This assumption requires that
companies report in discrete time
periods, like months, quarters and
 This allows the companies to send out
interim reports, and inform shareholders
of the activities of the company.
Measurement Principle
The measurement principle consists of mixed
 Historical cost – the acquisition price of an
asset is considered to be the primary
reported value for an asset or liability, unless
other values are more appropriate.
 Fair value – a market based measure that is
often more relevant that cost. Current use of
fair value for investments is increasing, and
international standards include even more fair
value applications.
The Revenue Recognition Principle
This principle determines when revenues
can be recognized.
 Revenue recognized when realized (or
realizable) and earned.
 This principle triggers the matching principle,
which is necessary for determining the
measure of performance.
 The most common point of revenue
recognition is when goods or services are
transferred or provided to the buyer (at
delivery); alternative recognition techniques
are discussed in later chapters.
The Expense Recognition Principle
Expense recognition focuses on the timing of
recognition of expenses after revenue recognition
has been determined.
 This principle states that the efforts of a given
period (expenses) should be matched against the
benefits (revenues) they generate.
 For example, the cost of inventory is initially
capitalized as an asset on the balance sheet; it is
not recorded in Cost of Goods Sold (expense) until
the sale is recognized.
Full Disclosure
Full disclosure requires the reporting of
information that is of sufficient importance to
influence the judgment and decisions of an
informed user.
Disclosure of information may be found in the
body of the financial statements, in the notes
to the financial statements, or in other
supplementary disclosures.
Cost Constraint – requires the FASB to
consider the cost to the company of
implementing a new standard and compare it
to the benefits of the standard to the users.
 Industry Practice – some industries have
developed long-standing practices for
treatment of certain accounting issues; the
treatments are not considered GAAP, but are
allowed for the industry for comparability and
 Note: one constraint is no longer mentioned
in the concepts: conservatism.