Conceptual Framework
Financial Statements / Financial Reporting
5
Recognition & Measurement Concepts
Assumptions, Principles & Concepts
4
Qualitative
Characteristics
Elements
2
3
1
Objectives
Objectives of Financial Reporting by
Business Enterprises: User Perspective
Financial reporting should provide:
(1) information useful in investment & credit decisions
(2) information useful in assessing cash flow prospect
(amount, timing & uncertainty), &
(3) information about enterprise resources, claims to
those resources, & changes therin.
*** ... individuals who have a reasonable understanding
of business & economic activities & are willing to
study the information with reasonable diligence.
SFAC 1
Qualitative Characteristics
Primary Qualities:
(1) Relevance
(a) Predictive value,
(b) Feedback value &
(c) Timeliness
(2) Reliability
(a) Verifiability
(b) Representational Faithfulness
(c) Neutrality
Secondary Qualities:
(1) Comparability (across firms)
(2) Consistency (over time)
SFAC 2
Elements of Financial Statements
•
•
•
•
Assets
Liabilities
Equity
Investments by
Owners
• Distributions to
Owners
• Comprehensive
Income
• Revenue
• Expenses
• Gains
• Losses
SFAC 6
• Assumptions
Recognition
&
Measurement
Concepts
–
–
–
–
Economic Entity
Going Concern
Monetary Unit
Periodocity
• Principles
–
–
–
–
Historical Cost
Revenue Recognition
Matching
Full disclosure
• Constraints
–
–
–
–
Cost-Benefits
Materiality
Industry Practice
Conservatism
Accounting Assumptions:
Economic Entity: The business or economic entity exists separate
& distinct from its owners, employees, suppliers & customers.
This assumption defines accounting boundaries, but not legal
boundaries.
Going Concern: General purpose accounting reports are
constructed under the assumption that the business enterprise will
continue in business for the foreseeable future. The current
relevance of the historical cost principle is based on the goingconcern assumption.
Monetary Unit: Economic activity of an entity are measured and
reported in the U.S. dollar. This assumes that the dollar has a
reasonably constant value over time in terms of purchasing power.
This assumption ignores inflation.
Periodocity: Assumes that the economic life of a business can be
divided into discrete time periods and that financial reports from
each period are interpretable.
Historical Cost Principle
Acquisition cost is the most objective and
verifiable basis upon which to account for
assets and liabilities. That is, it is reliable.
5 methods to measure assets & liabilities:
–
–
–
–
–
Historical cost
Current cost
Current market value
Net realizable (settlement) value
Present (discounted) value
Revenue Recognition Principle
Recognize Revenue when:
(a) realized or realizable &
(b) earned…………………….on the date of sale
exceptions:
(a) during production ... if the production process is long
… Ex: long-term construction contract
(b) end of production … if selling price & amount is certain
… ex: mining of certain minerals
(c) receipt of cash
… if the amount to be collected is
uncertain
Recognition
Revenue…………when realized or realizable & earned
Gains ……………when realized or realizable
Expenses ….……when economic benefits are consumed
in revenue-earning activities or when
future economic benefits are reduced or
eliminated
Losses …………..when future economic benefits are reduced
or eliminated
SFAC 5
Matching Principle
Expenses are matched to the revenue
generated in that accounting period
“let the expenses follow the revenues”
Full Disclosure Principle
Financial statements should include sufficient
information to permit the knowledgeable
reader to make an informed judgment about
the financial condition of the enterprise.
trade-offs:
-sufficient detail to make a difference
-presented in a condensed form for
understandability & to avoid information overload
Constraints:
Cost-Benefit: The cost of providing the information
should not exceed the benefits that can be derived
from the information.
Materiality: An item is material if its inclusion or
omission would influence or change the judgment of a
reasonable man. Materiality is based on relative size
& importance.
Industry Practice: The unique nature of some
industries and business concerns sometimes (rarely)
requires departure from basic theory.
Conservatism: Never overstate assets or income.
Financial Statements show:
• Statement of Financial Position
• Earnings
• Comprehensive Earnings (earnings adjusted
for the cumulative adjustment or other nonowner
changes in equity foreign currency translation)
• Cash Flows
• Transactions with Owners
A Hierarchy of Accounting Qualities
Users of
Accounting
Information
Decision Makers
Pervasive
Contraint
Benefits > Costs
Understandability
User Specific
Qualities
Primary
Qualities
Primary
Qualities
Secondary
Qualities
Threshold for
Recognition
Decision Usefulness
Relevance
Predictive Feedback TimeValue
Value
liness
Comparability
Materiality
Reliability
Verifiability
Neutral- Representational
ity
Faithfulness
Consistency
SFAC 2