The Conceptual Framework and Objectives of Financial Reporting

1
Chapter 1

• The Conceptual Framework and Objectives of
  Financial Reporting

2
What is Accounting Used For?

• Decision Making
• Evaluation of past performance
• Expectations of future performance
• Allocation of Resources

3
Free enterprise principle

• Resources will flow to the segments of the
  economy
• that will use them most efficiently in the
  creation of new wealth

4
Role of Accounting
Accounting Information
Investors
5
Chapter 1 -- Learning Objective

• 2. Trace the evolution of generally accepted
  accounting principles
• GAAP

6
GAAP

• A consensus
• The conventions, rules, and procedures necessary
  to define accepted accounting practice

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Sources of GAAP

• Committee on Accounting Procedures
• Accounting Principles Board
• Financial Accounting Principles Board

8
Committee on Accounting Procedure CAP1939 -
1959

• First private body concerned with writing
  accounting rules
• Issued 51 Accounting Research Bulletins
• Members were practicing CPAs
• An ad hoc approach

9
Accounting Principles Board APB1959 - 1973

• Appointed by the AICPA
• Primarily from public accounting
• Issued 31 APB Opinions
• Criticized for failing to deal with problems on a
  timely basis
• Many saw a need for independence

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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 FASB
• Contributions from industry CPA firms

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Financial Accounting Standards Board FASB
Established 1973

• 7 members
• Members are full time, well paid
• Responsible only to FAF
• Passage of standards requires 5 out of 7 votes

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Securities and Exchange Commission

• Appointed by President
• Reports to Congress
• Final authority on reporting by public companies

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International Accounting Standards

• International Accounting Standards Committee
• Standards less specific
• Principle Based
• Not allowed by SEC

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Accounting Standard Setting

• A political process

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Chapter 1 -- Learning Objective

• 3. Relate the objectives of financial reporting
  as stated in the conceptual framework to the
  accounting process

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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

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Conceptual FrameworkSFACs

• Objectives of Financial Reporting
• Qualitative Characteristics
• Objectives for Nonbusiness Organizations
• Recognition Measurement
• Elements of Financial Statements

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Objectives of Financial ReportingSFAC 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

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Chapter 1 -- Learning Objective

• 4. Interpret the meaning of the qualitative
  characteristics of accounting information
  enumerated in the conceptual framework

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Objectives

• Useful for decision making
• Information about future cash flows
• Information about resources, claims to resources,
  changes in resources
• Liquidity
• Solvency
• Flexibility
• Profitability

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Qualitative CharacteristicsSFAC No. 2

• Primary Qualities
• Understandability
• Relevance
• Reliability
• Secondary Qualities
• Comparability
• Consistency

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Relevance

• The capacity for information to make a difference
• Predictive Value
• Feedback Value
• Timeliness

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Reliability

• User has confidence in the information
• Verifiability
• Representational Faithfulness
• Neutrality

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Secondary Qualities

• ComparabilityWith other enterprises
• ConsistencyPeriod to Period
• Changes in accounting must be to Better principles

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Constraints

• Measurement and reporting practices are affected
  by
• Cost/benefits
• Materiality
• Industry practices

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Chapter 1 -- Learning Objective

• 5. Understand the assumptions and conventions
  underlying the recognition and measurement of
  accounting data for financial reporting

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Recognition and MeasurementSFAC No. 5

• Recognition
• Reporting an item in the financial statements
• Measurement
• The amount reported for an item in financial
  statements

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Recognition Criteria

• Definition
• Must meet definition of an element of financial
  statements found in SFAC No. 6
• Measurability
• Must be measurable with sufficient reliability
• Relevance
• Must be capable of making a difference
• Reliability
• Must be representationally faithful, verifiable
  neutral

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Basic Accounting Assumptions

• Economic entity
• Going concern (Continuity)
• Periodicity
• Monetary unit

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Basic Conventions and Practices

• Cost or other measurement attributes
• Revenue recognition
• Matching
• Conservatism
• Full disclosure

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Chapter 1 -- Learning Objective

• 6. Distinguish among the elements of the
  financial statements

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Elements of Financial StatementsSFAC No. 6

• Basic Building Blocks

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Elements of Financial Statements

• Assets
• Liabilities
• Equity
• Investments by owners
• Distributions to owners
• Comprehensive Income
• Revenues
• Expenses
• Gains
• Losses

Balance Sheet
Income Statement
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Chapter 1 -- Learning Objective

• 7. Understand how accounting information is
  used in investment decision models

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Investment Decision Model
Factors
Operating efficiency Capital generation Asset
productivity Financial leverage
Goal
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Chapter 1 -- Learning Objective

• 8. Develop an appreciation of ethical and moral
  considerations in business

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Decision Model

• Determine the Facts
• Define the ethical issues
• Identify major values
• Specify the Alternatives
• Compare values and alternatives
• Assess consequences
• Decide

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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