Chapter 2
Financial Reporting:
Its Conceptual
Framework
Intermediate Accounting 11th edition
Nikolai Bazley Jones
An electronic presentation
By Norman Sunderman
and Kenneth Buchanan
Angelo State University
COPYRIGHT © 2010 South-Western/Cengage Learning
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Objectives-Oriented Principles
 The SEC has recommended that future
accounting standards should not follow a rulesbased, nor principles only approach, but should
be “objectives-oriented.”
 Should be built on an improved and
consistently applied conceptual framework
 Clearly state the accounting objective
 Minimize exceptions
 Avoid the use of bright-line tests
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Charges Given to the FASB
To develop a
conceptual
framework of
accounting theory
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Charges Given to the FASB
To establish
standards (GAAP)
for financial
accounting practice
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FASB Conceptual Framework
1. To guide the FASB in establishing accounting
standards
2. To provide a frame of reference for resolving
accounting questions in situations where a
standard does not exist
3. To determine the bounds for judgment in the
preparation of financial statements
4. To increase users’ understanding of and
confidence in financial reporting
5. To enhance comparability
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Objectives of Financial Reporting
General Objective:
Provide information that is useful to
present and potential investors,
creditors, and other users in making
rational investment, credit, and
similar decisions
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Objectives of Financial Reporting
Derived External User Objective:
Provide information that is useful to
present and potential investors,
creditors, and other users in assessing
the amounts, timing, and uncertainty of
prospective cash receipts from
dividends and interest, and the proceeds
from the sale, redemption, or maturity
of securities or loans
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Objectives of Financial Reporting
Derived Company Objective:
Provide information to help
investors, creditors, and others in
assessing the amounts, timing, and
uncertainty of prospective net cash
inflows to the related company
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Objectives of Financial Reporting
Provide information
about a company’s cash
flows.
Provide information about a
company’s economic resources,
obligations, and owners’ equity.
Provide information about a
company’s comprehensive income
and its components.
Specific
Objectives
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Other Issues
First, financial reporting should
provide information about how the
management of a company has
discharged its stewardship
responsibility.
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Other Issues
Second, a company’s financial
statements and other means of financial
reporting should include explanations
and interpretations by its management
to help external users understand the
financial information provided.
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Other Issues
Providing this critical information
is known as full disclosure.
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Understandability
Accounting information should be
understandable to users who have a
reasonable knowledge of business
and economic activities and who are
willing to study the information
carefully.
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Decision Usefulness
Decision usefulness is the overall
qualitative characteristic to use in
judging the quality of accounting
information.
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Relevance
Accounting information is relevant if
it can make a difference in a
decision.
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Reliability
Accounting information is reliable when it
is reasonably free from error and bias, and
faithfully represents what it is intended to
represent.
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Hierarchy of Qualitative Characteristics
Comparability of accounting information
enables users to identify and explain
similarities and differences between two
or more sets of economic facts.
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Assumptions and Principles
Entity
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.
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Assumptions and Principles
Continuity
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.
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Assumptions and Principles
Period 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.
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Assumptions and Principles
Monetary 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.
The FASB encourages companies to prepare
supplemental disclosures about the impact of
changing prices.
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Assumptions and Principles
Historical Cost
Usually, the exchange price is retained in the
accounting records as the value of an item
until it is removed from the records.
Replacement
Cost
$13,000
Market
Value
$13,500
Cost
$16,000
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Assumptions and Principles
Historical Cost
Which amount
should be used?
Cost
$16,000
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Assumptions and Principles
Realization and Recognition
Realization is the process of converting
noncash resources and rights into cash or
rights to cash. Recognition is the process of
formally recording and reporting an item in
the financial statements of a company.
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Assumptions and Principles
Matching and Accrual Accounting
The matching
principle
states
that of
to
Accrual
accounting
is the
process
determine
thethe
income
of a company
relating
financial
effects of for an
accounting
period,
theand
company
computes
transactions,
events,
circumstances
the
totalcash
expenses
involvedto
inthe
obtaining
having
consequences
period the
in
revenues
of the
period
andthan
relates
thesethe
total
which they
occur
rather
to when
expenses
the total
revenuesoccurs.
recorded in
cash to
receipt
or payment
the period.
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Assumptions and Principles
Conservatism
The principle of conservatism 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.
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Balance Sheet
It also is called a
statement of
financial position.
A balance sheet is a financial
statement that summarizes the
financial position of a company
on a particular date.
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Balance Sheet
The elements of a balance sheet are:
 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
assets of a company that remains after
deducting its liabilities.
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Income Statement
An income statement is a financial
statement that summarizes the
results of a company’s operations
for a period of time.
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Income Statement
The elements of an income statement are:
 Revenues are inflows 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 or central
operations. Revenues increase the equity of a
company.
Continued
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Income Statement
The elements of an income statement are:
 Expenses are outflows 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 or central
operations. Expenses decrease the equity of a
company.
Continued
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Income Statement
The elements of an income statement are:
 Gains are increases in the equity of a company
from peripheral or incidental transactions, and
from all other events and circumstances during
a period, except those that result from revenues
or investments by owners.
Continued
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Income Statement
The elements of an income statement are:
 Losses are decreases in the equity of a
company from peripheral or incidental
transactions, and from all other events and
circumstances during a period, except those
that result from expenses or distribution to
owners.
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Income Statement
Expenses decrease
the equity of the
company.
Revenues increase
the equity of the
company.
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Statement of Cash Flows
A statement of cash flows is a financial
statement that summarizes the cash inflows and
outflows of a company for a period of time.
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Statement of Cash Flows
The elements of a statement of cash flows are:
 Operating cash flows are the inflows and
outflows of cash from acquiring, selling, and
delivering goods for sale, as well as providing
services.
 Investing cash flows are the inflows and
outflows of cash from acquiring and selling
investments, property, plant, and equipment, as
well as from lending money and collecting on
loans.
Continued
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Statement of Cash Flows
The elements of a statement of cash flows are:
 Financing cash flows are the inflows and
outflows of cash from obtaining resources from
owners and paying them dividends, as well as
obtaining and repaying resources from
creditors on long-term credit.
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Statement of Changes in Equity
A statement of changes in equity
summarizes the changes in a
company’s equity for a period of
time.
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Statement of Changes in Equity
A statement of changes in equity contains two
elements:
 Investments by owners are increases in the
equity of a company resulting from transfers
of something valuable to the company in order
to obtain or increase ownership interests.
 Distribution to owners are decreases in the
equity of a company caused by transferring
assets, rendering services, or incurring
liabilities.
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Model of Business Reporting
Framework of the Model
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
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IASB Framework
The IASB Framework is designed:
1. To help the Board in developing future
International Financial Reporting Standards
(IFRS) and reviewing existing standards.
2. To promote the harmonization of regulations,
accounting standards, and accounting
procedures regarding the preparation of
financial statements.
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IASB Framework
 In 2004, the FASB and the IASB added to their
respective convergence agendas a project to
develop a common conceptual framework.
 In addition to promoting international
harmonization of future accounting standards,
the result of this joint project should provide a
more consistent and unified set of concepts that
will result in accounting standards that are
principles based.
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FASB and IASB
As part of their convergence project, the FASB
and IASB are working on a joint project to
develop a common Conceptual Framework for
Financial Reporting. The Boards continue to feel
that financial reporting should be general
purpose, should be useful in assessing a
company’s future cash flows, and should provide
information about a company’s resources, claims
to those resources, and changes in these items
using accrual accounting.
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Chapter 2
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