Kieso_Inter_13e_Ch02 - CHAPTER 2 CONCEPTUAL FRAMEWORK...

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Unformatted text preview: CHAPTER 2 CONCEPTUAL FRAMEWORK UNDERLYING FINANCIAL ACCOUNTING Intermediate Accounting 13th Edition Kieso, Weygandt, and Warfield Chapter 2-1 Learning Objectives 1. 2. 3. 4. 5. 6. 7. 8. Describe the usefulness of a conceptual framework. Describe the FASB's efforts to construct a conceptual framework. Understand the objectives of financial reporting. Identify the qualitative characteristics of accounting information. Define the basic elements of financial statements. Describe the basic assumptions of accounting. Explain the application of the basic principles of accounting. Describe the impact that constraints have on reporting accounting information. Chapter 2-2 Conceptual Framework The Need for a Conceptual Framework To develop a coherent set of standards and rules To solve new and emerging practical problems The goal is to establish the objectives and concepts for use in developing standards of financial accounting and reporting. It is not to replace the need for standards and rules. Chapter 2-3 LO 1 Describe the usefulness of a conceptual framework. Development of Conceptual Framework The FASB has issued six Statements of Financial Accounting Concepts (SFAC) for business enterprises. SFAC No.1 Objectives of Financial Reporting SFAC No.2 Qualitative Characteristics of Accounting Information SFAC No.3 Elements of Financial Statements (superceded by SFAC No. 6) SFAC No.5 Recognition and Measurement in Financial Statements SFAC No.6 Elements of Financial Statements (replaces SFAC No. 3) SFAC No.7 Using Cash Flow Information and Present Value in Accounting Measurements Chapter 2-4 LO 2 Describe the FASB's efforts to construct a conceptualObjective 2 framework. ASSUMPTIONS 1. Economic entity 2. Going concern 3. Monetary unit 4. Periodicity PRINCIPLES 1. Measurement 2. Revenue recognition 3. Expense recognition 4. Full disclosure CONSTRAINTS 1. Cost-benefit 2. Materiality 3. Industry practice 4. Conservatism Third level = Recognition and Measurement Concepts. QUALITATIVE CHARACTERISTICS Relevance Reliability Comparability Illustration 2-7 Conceptual Framework for Financial Reporting Consistency ELEMENTS Assets, Liabilities, and Equity Investments by owners Distribution to owners Comprehensive income Revenues and Expenses Gains and Losses Second level = Qualitative Characteristics and Basic Elements 1. 2. 3. Chapter 2-5 OBJECTIVES Useful in investment and credit decisions Useful in assessing future cash flows About enterprise resources, claims to resources, and changes in them First level = Basic Objectives LO 2 Describe the FASB's efforts to construct a conceptual framework. First Level: Basic Objectives Review: According to the FASB conceptual framework, the objectives of financial reporting for business enterprises are based on? a. Generally accepted accounting principles b. Reporting on management's stewardship. c. The need for conservatism. d. The needs of the users of the information. The current proposed converged framework adopts the FASB's focus on investors and creditors. Chapter 2-6 LO 3 Second Level: Fundamental Concepts Question: How does a company choose an alternative acceptable, meaning GAAP, accounting method, the amount and types of information to disclose, and the format in which to present it? Answer: By determining which alternative provides the most useful information for decisionmaking purposes (decision usefulness). Chapter 2-7 LO 4 Identify the qualitative characteristics of accounting information. Second Level: Fundamental Concepts Qualitative Characteristics "The FASB identified the Qualitative Characteristics of accounting information that distinguish better (more useful) information from inferior (less useful) information for decisionmaking purposes." Chapter 2-8 LO 4 Identify the qualitative characteristics of accounting information. Second Level: Qualitative Characteristics Illustration 2-2 Hierarchy of Accounting Qualities Chapter 2-9 LO 4 Identify the qualitative characteristics of accounting information. Second Level: Qualitative Characteristics Review: Relevance and reliability are the two primary qualities that make accounting information useful for decision making. True To be reliable, accounting information must be capable of making a difference in a decision. False Chapter 2-10 LO 4 Identify the qualitative characteristics of accounting information. Second Level: Basic Elements Concepts Statement No. 6 defines ten interrelated elements that relate to measuring the performance and financial status of a business enterprise. "Moment in Time" Assets Liabilities Equity "Period of Time" Investment by owners Distribution to owners Comprehensive income Revenue Expenses Gains Losses LO 5 Define the basic elements of financial statements. Chapter 2-11 Second Level: Basic Elements Exercise 2-3: Identify the element or elements associated with items below. (a) Arises from peripheral or incidental transactions. (b) Obligation to transfer resources arising from a past transaction. (c) Increases ownership interest. (d) Declares and pays cash dividends to owners. (e) Increases in net assets in a period from nonowner sources. (a) Chapter 2-12 Elements (b) (c) (d) (e) (c) Assets Liabilities Equity Investment by owners Distribution to owners Comprehensive income Revenue Expenses Gains Losses LO 5 (a) Second Level: Basic Elements Exercise 2-3: Identify the element or elements associated with items below. (f) Items characterized by future economic benefit. (g) Equals increase in net assets during the year, after adding distributions to owners and subtracting investments by owners. (g) (h) Arises from income statement activities that constitute the entity's ongoing major or central operations. Chapter 2-13 (f) (b) (c) (d) (e) (c) (h) (h) (a) (a) Elements Assets Liabilities Equity Investment by owners Distribution to owners Comprehensive income Revenue Expenses Gains Losses LO 5 Second Level: Basic Elements Exercise 2-3: Identify the element or elements associated with items below. (i) Residual interest in the net assets of the enterprise. (j) Increases assets through sale of product. (k) Decreases assets by purchasing the company's own stock. (l) (g) (l) Changes in equity during the period, except those from investments by owners and distributions to owners. (k) (e) (j) (f) (b) (i) (c) (d) (c) (h) (h) (a) Chapter 2-14 Elements Assets Liabilities Equity Investment by owners Distribution to owners Comprehensive income Revenue Expenses Gains Losses LO 5 (a) Second Level: Basic Elements Review: According to the FASB conceptual framework, an entity's revenue may result from a. A decrease in an asset from primary operations. b. An increase in an asset from incidental transactions. c. An increase in a liability from incidental transactions. d. A decrease in a liability from primary operations. (CPA adapted) Chapter 2-15 LO 5 Define the basic elements of financial statements. Third Level: Recognition and Measurement The FASB sets forth most of these concepts in its Statement of Financial Accounting Concepts No. 5, "Recognition and Measurement in Financial Statements of Business Enterprises." ASSUMPTIONS 1. Economic entity 2. Going concern 3. Monetary unit 4. Periodicity PRINCIPLES 1. Measurement 2. Revenue recognition 3. Expense recognition 4. Full disclosure CONSTRAINTS 1. Cost-benefit 2. Materiality 3. Industry practice 4. Conservatism Chapter 2-16 LO 6 Describe the basic assumptions of accounting. Third Level: Assumptions Economic Entity company keeps its activity separate from its owners and other businesses. and commitments. Going Concern company to last long enough to fulfill objectives Monetary Unit money is the common denominator. Periodicity company can divide its economic activities into time periods. Chapter 2-17 LO 6 Describe the basic assumptions of accounting. Third Level: Assumptions Brief Exercise 2-4: Identify which basic assumption of accounting is best described in each item below. (a) The economic activities of KC Corporation are divided into 12month periods for the purpose of issuing annual reports. (b) Solectron Corporation, Inc. does not adjust amounts in its financial statements for the effects of inflation. (c) Walgreen Co. reports current and noncurrent classifications in its balance sheet. (d) The economic activities of General Electric and its subsidiaries are merged for accounting and reporting purposes. Periodicity Monetary Unit Going Concern Economic Entity Chapter 2-18 LO 6 Describe the basic assumptions of accounting. Third Level: Principles Measurement The most commonly used measurements are based on historical cost and fair value. Issues: Historical cost provides a reliable benchmark for measuring historical trends. Fair value information may be more useful. Recently the FASB has taken the step of giving companies the option to use fair value as the basis for measurement of financial assets and financial liabilities. Reporting of fair value information is increasing. Chapter 2-19 LO 7 Explain the application of the basic principles of accounting. Third Level: Principles Revenue Recognition generally occurs (1) when realized or realizable and (2) when earned. Exceptions: Longterm construction contracts, Endofproduction recognition commodities Receipt of Cash High Risk Collections Chapter 2-20 LO 7 Explain the application of the basic principles of accounting. Third Level: Principles Expense Recognition "Let the expense follow the revenues." Illustration 2-5 Expense Recognition Chapter 2-21 LO 7 Explain the application of the basic principles of accounting. Third Level: Principles Full Disclosure providing information that is of sufficient Provided through: Financial Statements Notes to the Financial Statements Supplementary information importance to influence the judgment and decisions of an informed user. Chapter 2-22 LO 7 Explain the application of the basic principles of accounting. Third Level: Principles Brief Exercise 2-5: Identify which basic principle of accounting is best described in each item below. Revenue (a) KC Corporation reports revenue in its income statement when it is Recognitio earned instead of when the cash is collected. n (b) Yahoo, Inc. recognizes depreciation expense for a machine over the 2year period during which that machine helps the company earn revenue. (c) Oracle Corporation reports information about pending lawsuits in the notes to its financial statements. (d) Eastman Kodak Company reports land on its balance sheet at the amount paid to acquire it, even though the estimated fair market value is greater. Chapter 2-23 Expense Recognitio n Full Disclosure Measurement LO 7 Explain the application of the basic principles of accounting. Third Level: Constraints Cost Benefit the cost of providing the information must be weighed against the benefits that can be derived from using it. influence or change the judgment of a reasonable person. Materiality an item is material if its inclusion or omission would Industry Practice the peculiar nature of some industries and business concerns sometimes requires departure from basic accounting theory. least likely to overstate assets and income. Conservatism when in doubt, choose the solution that will be Chapter 2-24 LO 8 Describe the impact that constraints have on reporting accounting information. Third Level: Constraints Brief Exercise 2-7: What accounting constraints are illustrated by the items below? (a) KC, Inc. reports agricultural crops on its balance sheet at market value. (b) Rafael Corporation does not accrue a contingent lawsuit gain of $650,000. (c) Willis Company does not disclose any information in the notes to the financial statements unless the value of the information to users exceeds the expense of gathering it. (d) Favre Corporation expenses the cost of wastebaskets in the year they are acquired. Chapter 2-25 Industry Practice Conservatism CostBenefit Materiality LO 8 The existing conceptual frameworks underlying U.S. GAAP and iGAAP are very similar. The converged framework should be a single document, unlike the two conceptual frameworks that presently exist. The IASB framework makes two assumptions. One assumption is that financial statements are prepared on an accrual basis; the other is that the reporting entity is a going concern. There is some agreement that the role of financial reporting is to assist users in decision making. However, others note that another objective is to provide information on management's performance, often referred to as stewardship. Chapter 2-26 ...
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This note was uploaded on 04/14/2010 for the course TOBIN 615 taught by Professor Alan during the Spring '10 term at Adams State University.

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