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Chapter 2
Financial
Reporting:
Its Conceptual
Framework
An electronic presentation
by Douglas Cloud
Pepperdine University
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Objectives
1. Explain the FASB conceptual framework.
2. Understand the relationship among the
objectives of financial reporting.
3. Identify the general objective of financial
reporting.
4. Describe the three specific objectives of
financial reporting.
Continued
3
Objectives
5. Discuss the types of useful information for
investment and credit decision making.
6. Explain the qualities of useful accounting
information.
7. Understand the accounting assumptions and
conventions that influence GAAP.
8. Define the elements of financial statements.
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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
practices.
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FASB Conceptual Framework
 To guide the FASB in establishing accounting
standards.
 To provide a frame of reference for resolving
accounting questions in situations where a
standard does not exist.
 To determine the bounds for judgment in the
preparation of financial statements.
 To increase users’ understanding of and
confidence in financial reporting.
 To enhance comparability.
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Relationship of Conceptual Framework
and Standard-Setting Process
Conceptual Framework
Terms
P
u
r
p
o
s
e
Objectives and Concepts
Identify goals and
purpose of accounting
Documents
Guide the selection of events to
be accounted for, the
measurement of these events, and
the means of summarizing and
communicating the information
to external users,
Statements of Financial
Accounting Concepts
Continued
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Relationship of Conceptual Framework
and Standard-Setting Process
From
Objectives
and Concepts
Statements of
Financial
Accounting
Concepts
Standard Setting
Standards
Establish methods and
procedures for measuring,
summarizing, and
communicating financial
accounting information to
external users.
Statements of Financial
Accounting Standards
Conceptual Framework Projects for
Financial Accounting and Reporting
Objective
Project
Accounting
Projects
Reporting
Projects
Qualitative Characteristics
Project
continued
continued
continued
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Conceptual Framework Projects for
Financial Accounting and Reporting
Reporting
Projects
Accounting
Projects
Qualitative Characteristics
Project
Elements
Recognition
Measurement
Financial Statements
and Financial
Reporting
Income
Cash Flow and
Liquidity
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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
related company.
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Objectives of Financial Reporting
Specific
Objectives
Provide
Provide
Provide
information
information
information
about
about
a a
about
company’s
company’s
a company’s
comprehensive
economic
cashresources,
income
obligations,
and
flows.
itsand
components.
owners’ equity.
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Other Issues
First, financial reporting
should provide information
about how the management
of a company has discharged
its stewardship
responsibilities.
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Other Issues
Second, financial statements and
other means of financial reporting
should include explanations and
interpretations to 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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Interrelationship of Final Reports, Useful
Information, and Decision Making
Communication
Documents
Types of Useful Information
External
Decision Making
Return on Investment
Risk
Financial
Reports
Buy
Hold
Sell
Financial Flexibility
Liquidity
Operating Capability
Extend Credit
Continue
Credit
Deny Credit
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Hierarchy of Qualitative Characteristics
Accounting Information
Benefits>Costs
Pervasive
Constraint
Understandability
User- Usefulness
Decision
Specific
Quality
Overall
Relevance Quality
Continued
Reliability
Primary Decision-Specific Qualities
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Hierarchy of Qualitative Characteristics
Relevance
Reliability
Representational
faithfulness
Threshold
for
Secondary
Comparability (including Recognition
and
of Primary Qualities
InteractiveIngredients Consistency
Qualities
Materiality
Predictive
Value
Feedback
Value
Timeliness
Verifiability
Neutrality
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Hierarchy of Qualitative Characteristics
Accounting information is
relevant if it can make a
difference in a decision.
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Hierarchy of Qualitative Characteristics
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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Constraints to the Hierarchy
Are
benefits
greater
than
costs?
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Constraints to the Hierarchy
Materiality
• The nature of the item.
• The relative size rather
than absolute size of an
item.
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Assumptions and Conventions
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 Conventions
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 goingconcern assumption.
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Assumptions and Conventions
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 Conventions
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
Market
Value
Cost
Cost
$13,500
$16,000
$13,000
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Assumptions and Conventions
Historical Cost
Which amount
should be used?
Cost
$16,000
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Assumptions and Conventions
Monetary Unit
This assumption states that there must
be some basis for measuring exchange
TheorFASB
encourages
of goods
services.
Currently the
to prepare
dollarcompanies
is considered
to be a stable
supplemental
disclosures
monetary
unit for
preparing a
aboutfinancial
the impact
of
company’s
statements.
changing prices.
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Assumptions and Conventions
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 Conventions
Matching and Accrual Accounting
Accrual
accountingprinciple
is the process
of that
relating
The matching
states
to
the financial
of transactions,
events,
determine
theeffects
income
of a company
for an
and circumstances
having
cash consequences
accounting
period,
the company
computes
to the period in which they occur rather than
the
total
expense
involved
in
obtaining
to when the cash receipt or payment occurs.
the revenues of the period and relates
these total expenses to the total revenues
recorded in the period.
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Assumptions and Conventions
Conservatism
The conservatism convention 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
Elements of a balance sheet:
 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 net
assets of a company.
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Income Statement
An income statement is a
financial statement that
summarizes the results of a
company’s operations.
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Income Statement
The elements of the income statement are:
 Revenues are inflows or other
enhancements 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 operation.
Revenues increase the equity of a company.
Continued
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Income Statement
The elements of the income statement are:
 Expenses are outflows or other using up 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 operation.
Expenses decrease the equity of a company.
Continued
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Income Statement
The elements of the income statement are:
 Gains are increases in the equity of a
company from peripheral or incidental
transactions and from all other transactions
and other events and circumstances
affecting the company, except those that
result from revenues or investments by
owners. Gains increase the equity of a
company.
Continued
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Income Statement
The elements of the income statement are:
 Losses are decreases in the equity of a
company, from peripheral or incidental
transactions except those that result from
expenses or distribution to owners. Losses
decrease the equity of a company.
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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.
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Statement of Cash Flows
The elements of a statement of cash flows are:
o Operating cash flows are the flows of cash from
acquiring, selling, and delivering goods for sale,
as well as providing services.
o Investing cash flows are the flows of cash from
acquiring and selling investments, property, plant,
and equipment, as well as from lending money
and collecting on loans.
o Financing cash flows are the flows of cash to and
from the owners and long-term creditors.
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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.
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Statement of Changes in Equity
A statement of changes in equity contains two
elements:
 Investments by owners are increases in equity
resulting from transfers of something valuable to
the company from other entities in order to obtain
or increase ownership interest.
 Distribution to owners are decreases in equity of
a company caused by transferring assets,
rendering services, or incurring liabilities to
owners.
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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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Chapter 2
The End