ch02 - CHAPTER 2 CONCEPTUAL FRAMEWORK CONCEPTUAL UNDERLYING...

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Unformatted text preview: CHAPTER 2 CONCEPTUAL FRAMEWORK CONCEPTUAL UNDERLYING FINANCIAL ACCOUNTING Intermediate Accounting Prof. Volkan Muslu Chapter 2 -1 Conceptual Framework The Need for a Conceptual Framework To de lop a cohe nt se of standards and rule ve re t s To solvene and e e w m rging practical proble s m Chapter 2 -2 LO 1 Describe the usefulness of a conceptual framework. Development of Conceptual Framework TheFAS has issue six Statements of Financial B d Accounting Concepts (S FAC for busine e rprise ) ss nte s. SFAC No.1 - Obje s of Financial Re ctive porting SFAC No.2 - QualitativeC haracte ristics of Accounting I nform ation SFAC No.3 - Ele e of Financial S m nts (supe de by m nts tate e rce d S FACNo. 6) SFAC No.5 - Re cognition and Me asure e in Financial S m nts m nt tate e SFAC No.6 - Ele e of Financial S m nts (re m nts tate e place S s FACNo. 3) SFAC No.7 - Using C Flow I nform ash ation and Pre nt Valuein Accounting se Me asure e m nts Chapter 2 -3 LO 2 Describe the FASB’s efforts to construct a conceptualObjective 2 framework. Conceptual Framework The Framework is comprised of three levels: First Level = Basic Obje s ctive Second Level = QualitativeC haracte ristics and Basic Ele e m nts Third Level = Re cognition and Me asure e C pts. m nt once The FASB and the IASB have agreed on a joint project to develop a common and improved conceptual framework. Chapter 2 -4 LO 2 Describe the FASB’s efforts to construct a conceptual 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 QUALITATIVE QUALITATIVE CHARACTERISTICS 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 1. 1. 2. 2. 3. 3. Chapter 2 -5 OBJECTIVES Useful in investment and credit decisions and Useful in assessing future cash flows future About enterprise resources, claims to resources, and changes in them changes First level LO 2 Describe the FASB’s LO efforts to construct a conceptual framework. conceptual First Level: Basic Objectives First Financial re ation that: Financial porting should provideinform (a) is useful t o pre nt and pote se ntial inve stors and cre ditors and othe use in r rs useful m aking rational investment, credit, and similar decisions. rational (b) helps pre nt and pote ntial inve stors and cre ditors and othe use in r rs helps se assessing the amounts, timing, and uncertainty of prospective cash receipts. prospective (c) portrays theeconomic resources of an e rprise theclaims to those nte , resources, and thee cts of transactions, e nts, and circum ffe ve stance that s resources and change its resources and claims to those resources. change Chapter 2 -6 LO 3 Understand the objectives of financial reporting. Second Level: Fundamental Concepts Qualitative Characteristics “TheFAS ide B ntifie theQualitative Characteristics of d accounting inform ation that distinguish be r (m use inform tte ore ful) ation f rominfe (le use inform rior ss ful) ation for de cision-m aking purpose s.” Chapter 2 -7 LO 4 Identify the qualitative characteristics of accounting information. Second Level: Qualitative Characteristics Illustration 2-2 Hierarchy of Accounting Qualities Chapter 2 -8 LO 4 Identify the qualitative characteristics of accounting information. Second Level: Fundamental Concepts Understandability A com pany m pre nt highly re vant and re ay se le liableinform ation, howe r it was use ss to thosewho do not unde ve le rstand it. Chapter 2 -9 LO 4 Identify the qualitative characteristics of accounting information. ASSUMPTIONS 1. Economic entity 2. Going concern 3. Monetary unit 4. Periodicity PRINCIPLES 1. Measurement 2. Revenue recognition 4. Full disclosure CONSTRAINTS 1. Cost-benefit 2. Materiality Comparability and Consistency 3. Expense recognition 3. Industry practice 4. Conservatism QUALITATIVE QUALITATIVE CHARACTERISTICS CHARACTERISTICS Relevance Reliability Comparability Consistency ELEMENTS Assets, Liabilities, and Equity Investments by owners Distribution to owners Comprehensive income Revenues and Expenses Gains and Losses Third level Second level Illustration 2-7 Conceptual Framework for Financial Reporting 1. 1. 2. 2. 3. 3. Chapter 2-10 OBJECTIVES Useful in investment and credit decisions and Useful in assessing future cash flows future About enterprise resources, claims to resources, and changes in them changes First level LO 4 Identify the qualitative LO characteristics of accounting information. accounting Second Level: Qualitative Characteristics Primary Qualities: Relevance – m aking a diffe ncein a de re cision. Pre dictivevalue Fe dback value e Tim line e ss Reliability Ve rifiable Re se pre ntational faithfulne (no e ss rrors) Ne utrality (no bias) In the proposed converged conceptual framework, reliability will be replaced with “faithful representation” as one of the primary qualitative characteristics that must be present for information to be useful. Chapter 2-11 LO 4 Second Level: Qualitative Characteristics Secondary Qualities: Comparability – I nformation that is me d and re d in a asure porte sim m r for diffe nt com ilar anne re panie is conside d com s re parable . Consistency - Whe a company applies thesameaccounting n t re e to sim e nts frompe to pe atm nt ilar ve riod riod. Chapter 2-12 LO 4 Identify the qualitative characteristics of accounting information. ASSUMPTIONS 1. Economic entity 2. Going concern 3. Monetary unit 4. Periodicity PRINCIPLES 1. Measurement 2. Revenue recognition 4. Full disclosure CONSTRAINTS 1. Cost-benefit 2. Materiality Basic Elements Industry practice 3. Expense recognition 3. 4. Conservatism ELEMENTS Assets, Liabilities, and Equity Investments by owners Distribution to owners Comprehensive income Revenues and Expenses Gains and Losses Third level QUALITATIVE QUALITATIVE CHARACTERISTICS CHARACTERISTICS Relevance Reliability Comparability Illustration 2-7 Conceptual Framework for Financial Reporting Consistency Second level 1. 1. 2. 2. 3. 3. Chapter 2-13 OBJECTIVES Useful in investment and credit decisions and Useful in assessing future cash flows future About enterprise resources, claims to resources, and changes in them changes First level LO 5 Define the basic elements LO of financial statements. of Second Level: Basic Elements Concepts Statement No. 6 de s te inte late e m nts that fine n rre d le e re to m asuring thepe late e rform anceand financial status of a busine ss e rprise nte . “Moment in Time” Asse ts Asse (futuree ic ne ld) (future conom be fits he “Period of Time” I nve e by owne stm nt rs Distribution to owne rs C pre nsiveincom om he e Re nue(major or central operations) ve (m Re Expe s (major or central operations) nse Expe (m Gains (peripheral or incidental) Gains(pe Losse (peripheral or incidental) s Losse (pe Liabilitie s (futuresacrifice of be fits) s ne Equity (Re sidual owne rship inte st: Asse re tsLiabilitie s) Liabilitie Chapter 2-14 LO 5 Define the basic elements of financial statements. Second Level: Basic Elements Exercise 2-3: I de ntify thee m nt or e m nts associate with ite s be le e le e d m low. Elements (a) Arise frompe s riphe or incide ral ntal (a) transactions. t ransactions. (b) Obligation to transfe re r source arising s (b) froma past transaction. f rom (c) I ncre s owne ase rship inte st. re (d) De s and pays cash divide to nds (d) clare owne rs. owne (e I ncre s in ne asse in a pe from ) ase t ts riod (e nonowne source r s. nonowne (a) Chapter 2-15 Asse ts (b) (c) (d) (e ) (c) Liabilitie s Equity Equity I nve e by owne stm nt rs Distribution to owne rs C pre nsiveincom om he e Re nue ve Expe s nse Gains Gains Losse s Losse LO 5 (a) Second Level: Basic Elements Exercise 2-3: I de ntify thee m nt or e m nts associate with ite s be le e le e d m low. Elements (f) I te s characte d by future m rize e conom be fit. ic ne (g) Equals incre in ne asse during ase t ts Equals t heye afte adding distributions ar, r t o owne and subtracting rs inve e by owne stm rs. inve nts (g) (h) Arise fromincom state e s e m nt Arise activitie that constitutethe s e ntity’s ongoing m or ce ajor ntral ope rations. ope Chapter 2-16 (f) (b) (c) (d) (e ) (c) (h) (h) (a) (a) Asse ts Liabilitie s Equity Equity I nve e by owne stm nt rs Distribution to owne rs C pre nsiveincom om he e Re nue ve Expe s nse Gains Gains Losse s Losse LO 5 Second Level: Basic Elements Exercise 2-3: I de ntify thee m nt or e m nts associate with ite s be le e le e d m low. Elements (i) Re sidual inte st in thene asse of re t ts (i) thee rprise . t he nte (j) I ncre s asse through saleof ase ts (j) product. product. (k) De ase asse by purchasing the cre s ts (k) com pany’s own stock. com (l) riod, (l) C s quity during thepe (g) (l) hange in e e pt thosefrominve e by xce stm nts owne and distributions to owne rs rs. owne (k) (e ) (j) (f) (b) (i) (c) (d) (c) (h) (h) (a) Chapter 2-17 Asse ts Liabilitie s Equity Equity I nve e by owne stm nt rs Distribution to owne rs C pre nsiveincom om he e Re nue ve Expe s nse Gains Gains Losse s Losse LO 5 (a) Second Level: Basic Elements Review: According to theFAS conce B ptual fram work, an e e ntity’s re nuem ve ay According re from sult re a. b. c. d. A de asein an asse fromprim ope cre t ary rations. An incre in an asse fromincide transactions. ase t ntal An incre in a liability fromincide transactions. ase ntal A de asein a liability fromprim ope cre ary rations. (C adapte PA d) Chapter 2-18 LO 5 Define the basic elements of financial statements. Third Level: Recognition and Measurement TheFAS se forth m of the conce in its Statement of B ts ost se pts Financial Accounting Concepts No. 5, “Re cognition and Me asure e in Financial S m nts of Busine Ente m nt tate e ss rprise s.” 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 2-19 LO 6 Describe the basic assumptions of accounting. Third Level: Assumptions Economic Entity – company ke ps its activity separatefromits e owne and othe busine s. rs r sse Going Concern - company to last long enough to fulfill obje s ctive and com itm nts. me Monetary Unit - money is thecommon denominator. No inflation/ de flation adjustm nt. e Periodicity - company can divideits economic activitie into s artificial tim pe e riods. Annual, quarte filings. rly Chapter 2-20 LO 6 Describe the basic assumptions of accounting. Third Level: Assumptions Brief Exercise 2-4: I de ntify which basic assum ption of accounting is be st de scribe in e ite be d ach m low. (a) Thee conom activitie of KCC ic s orporation aredivide into d 12-m onth pe riods for thepurposeof issuing annual re ports. (b) S ctron Corporation, I nc. doe not adjust am ole s ounts in its f inancial state e for thee cts of inflation. m nts ffe (c) Walgre n Co. re e ports curre and noncurre classifications nt nt in its balanceshe t. e (d) Thee conom activitie of Ge ral Ele ic s ne ctric and its subsidiarie arem rge for accounting and re s ed porting purpose s. Periodicity Monetary Unit Going Concern Economic Economic Entity Entity Chapter 2-21 LO 6 Describe the basic assumptions of accounting. Third Level: Principles Measurement – Themost commonly used measure ents arebased on m historical cost and fair value. I ssue s: The clash !! y Historical cost: re liable(acquisition price). Fair value re vant (pricein an orderly transaction; Levels 1, 2, 3). : le Re ntly theFAS has take theste of giving com ce B n p panie theoption to use s f air valueas thebasis for m asure e of financial asse and financial e m nt ts liabilitie s. Re porting of fair valueinform ation is incre asing. Chapter 2-22 LO 7 Explain the application of the basic principles of accounting. Third Level: Principles Revenue Recognition - ge rally occurs (1) when re d or ne alize re alizableand (2) whe e d (substantially accomplished). n arne • Exceptions Illustration 2-4 Timing of Revenue Recognition Chapter 2-23 LO 7 Explain the application of the basic principles of accounting. Third Level: Principles Expense Recognition - “Let theexpensefollow therevenues.” • Exce ption: C hargeto curre nt pe whe cannot de rm a riod n te ine conne ction with a spe re nue cific ve Illustration 2-5 Expense Recognition Chapter 2-24 LO 7 Explain the application of the basic principles of accounting. Third Level: Principles Full Disclosure – providing information that is of sufficient importance t o influe thejudgm nt and de nce e cisions of an inform d use e r. But it has to beunderstandable t o a reasonable inve stor. Provide through: d Financial S m nts tate e Note to theFinancial S m nts s tate e S upple e m ntary inform ation Chapter 2-25 LO 7 Explain the application of the basic principles of accounting. Third Level: Principles Brief Exercise 2-5: I de ntify which basic principleof accounting is be de st scribe in e ite be d ach m low. Revenue Revenue (a) KCCorporation re ports re nuein its incom state e whe it is ve e m nt n Recognitio Recognitio e d inste of whe thecash is colle d. arne ad n cte n (b) Yahoo, I nc. re cognize de ciation e nsefor a m s pre xpe achineove the r 2-ye pe during which that m ar riod achinehe thecom lps pany e arn re nue ve . (c) OracleC orporation re ports inform ation about pe nding lawsuits in t henote to its financial state e s m nts. (d) Eastm Kodak Com an pany re ports land on its balanceshe t at the e am ount paid to acquireit, e n though thee ate fair m t ve stim d arke valueis gre r. ate Expense Expense Recognitio Recognitio n Full Full Disclosure Disclosure Measurement Chapter 2-26 LO 7 Explain the application of the basic principles of accounting. Third Level: Constraints Third Cost Benefit – t hecost of providing theinformation must be we d against thebe fits that can bede d fromusing it. ighe ne rive Materiality - an itemis material if its inclusion or omission would influe or changethejudgm nt of a re nce e asonablepe rson. (m rial stuff ate cannot bene d to be eim ate tte com m rial!) Industry Practice - t hepeculiar natureof someindustries and busine conce som tim s re ss rns e e quire de s parturefrombasic accounting t he ory. Conservatism – when in doubt, choosethesolution that will be le like to ove ast ly rstateasse and incom . ts e Chapter 2-27 LO 8 Describe the impact that constraints have on LO reporting accounting information. reporting Third Level: Constraints Brief Exercise 2-7: What accounting constraints areillustrate by d t heite s be m low? (a) KC I nc. re , ports agricultural crops on its balanceshe t at e m t value arke . (b) Rafae C l orporation doe not accruea continge lawsuit s nt gain of $650,000. (c) Willis C pany doe not discloseany inform om s ation in the note to thefinancial state e unle thevalueof the s m nts ss inform ation to use e e thee nseof gathe it. rs xce ds xpe ring (d) FavreC orporation e nse thecost of waste xpe s baske in the ts ye the areacquire ar y d. Chapter 2-28 Industry Industry Practice Practice Conservatism CostBenefit Materiality LO 8 Thee xisting conce ptual fram works unde e rlying U.S GAAP and iGAAP areve sim . ry ilar. Theconve d fram work should bea singledocum nt, unlikethetwo conce rge e e ptual f ram works that pre ntly e e se xist. TheI AS fram work m s two assum B e ake ptions. Oneassum ption is that financial state e arepre d on an accrual basis; theothe is that there m nts pare r porting e ntity is a going conce rn. The is som agre m nt that theroleof financial re re e ee porting is to assist use in de rs cision m aking. Howe r, othe notethat anothe obje ve rs r ctiveis to provideinform ation on m anage e pe m nt’s rform , ofte re rre to as ste ance n fe d wardship. Chapter 2-29 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 QUALITATIVE QUALITATIVE CHARACTERISTICS 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 1. 1. 2. 2. 3. 3. Chapter 2-30 OBJECTIVES Useful in investment and credit decisions and Useful in assessing future cash flows future About enterprise resources, claims to resources, and changes in them changes First level LO 2 Describe the FASB’s LO efforts to construct a conceptual framework. conceptual ...
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