Chapter 1 The Conceptual Framework and Objectives of Financial Reporting.

Chapter 1

The Conceptual Framework and Objectives of Financial Reporting

What is Accounting Used For?

• Decision Making– Evaluation of past performance– Expectations of future performance

• Allocation of Resources

Free enterprise principle

Resources will flow to the segments of the economy

that will use them most efficiently in the creation of new wealth

Role of Accounting

Accounting Information

Investors

Chapter 1 -- Learning Objective

2. Trace the evolution of generally accepted accounting

principles

GAAP

GAAP

A consensus

The conventions, rules, and procedures necessary to define accepted accounting

practice

Sources of GAAP

Committee on Accounting ProceduresAccounting Principles BoardFinancial Accounting Principles Board

Committee on Accounting Procedure

CAP1939 - 1959

First private body concerned with writing accounting rules

Issued 51 Accounting Research BulletinsMembers were practicing CPAsAn “ad hoc” approach

Accounting Principles Board

APB1959 - 1973

Appointed by the AICPAPrimarily from public accountingIssued 31 APB OpinionsCriticized for failing to deal with

problems on a timely basis Many saw a need for independence

Financial Accounting Foundation

FAF Established 1973

Appoints members of Financial Accounting Standards Board (FASB)

Appoints members of Financial Accounting Standards Advisory Committee (FASAC)

Provides financial support to FASBContributions from industry & CPA firms

Financial Accounting Standards Board

FASB Established 1973

7 membersMembers are full time, well paidResponsible only to FAFPassage of standards requires 5 out of 7

votes

Securities and Exchange Commission

• Appointed by President

• Reports to Congress

• Final authority on reporting by public companies

International Accounting Standards

• International Accounting Standards Committee

• Standards less specific

• “Principle Based”

• Not allowed by SEC

Accounting Standard Setting

• A political process

Chapter 1 -- Learning Objective

3. Relate the objectives of financial reporting as stated in the

conceptual framework to the accounting process

Conceptual Framework

Statements of Financial Accounting Concepts (SFACs)

Purpose:Establish the objectives and concepts to be used by the FASB in developing standards for financial reporting

Conceptual Framework

SFACs

1 Objectives of Financial Reporting

2 Qualitative Characteristics

4 Objectives for Nonbusiness Organizations

5 Recognition & Measurement

6 Elements of Financial Statements

Objectives of Financial Reporting

SFAC No. 1

To provide information:

1.Useful in investment and credit decisions

2.Useful in assessing future cash flows

3.About enterprise resources, claims and changes

Chapter 1 -- Learning Objective

4. Interpret the meaning of the qualitative characteristics of

accounting information enumerated in the conceptual framework

Objectives

• Useful for decision making• Information about future cash flows• Information about resources, claims to

resources, changes in resources– Liquidity– Solvency– Flexibility– Profitability

Qualitative Characteristics

SFAC No. 2

� Primary Qualities� Understandability* Relevance* Reliability

� Secondary Qualities* Comparability* Consistency

RelevanceThe capacity for information to make a difference

Predictive Value

Feedback Value

Timeliness

ReliabilityUser has confidence in the information:

Verifiability

Representational Faithfulness

Neutrality

Secondary Qualities

• Comparability—With other enterprises

• Consistency—Period to Period– Changes in accounting must be to Better

principles

ConstraintsMeasurement and reporting practices are affected by:

Cost/benefits

Materiality

Industry practices

Chapter 1 -- Learning Objective

5. Understand the assumptions and conventions underlying the

recognition and measurement of accounting data for financial reporting

Recognition and Measurement

SFAC No. 5

� Recognition* Reporting an item in the financial statements

� Measurement* The amount reported for an item in financial

statements

Recognition Criteria1 Definition

� Must meet definition of an element of financial statements found in SFAC No. 6

2 Measurability� Must be measurable with sufficient reliability

3 Relevance� Must be capable of making a difference

4 Reliability� Must be representationally faithful, verifiable & neutral

Basic Accounting Assumptions:

Economic entity

Going concern (Continuity)

Periodicity

Monetary unit

Basic Conventions and Practices

Cost or other measurement attributes

Revenue recognition

Matching

Conservatism

Full disclosure

Chapter 1 -- Learning Objective

6. Distinguish among the elements of the financial statements

Elements of Financial StatementsSFAC No. 6

Basic Building Blocks

Elements of Financial Statements• Assets

• Liabilities

• Equity

• Investments by owners

• Distributions to owners

• Comprehensive Income

• Revenues

• Expenses

• Gains

• Losses

Balance Sheet

Income Statement

Chapter 1 -- Learning Objective

7. Understand how accounting information is used in

investment decision models

Investment Decision Model

Growth potential

Goal

FactorsOperating efficiency

Capital generation

Asset productivity

Financial leverage

Income Statement

Balance Sheet

Chapter 1 -- Learning Objective

8. Develop an appreciation of ethical and moral considerations in

business

Decision Model

1. Determine the Facts

2. Define the ethical issues

3. Identify major values

4. Specify the Alternatives

5. Compare values and alternatives

6. Assess consequences

7. Decide

Decision Model forEthical Dilemmas

1.Determine the facts

2.Define the ethical issue

3.Identify major values

4.Specify the alternatives

5.Compare values and alternatives

6.Assess the consequences

7.Make the decision