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Chapter 2 Notes - Chapter 2 Conceptual Framework Underlying...

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Chapter 2: Conceptual Framework Underlying Financial Accounting Conceptual Framework - Like a constitution, “a coherent system of interrelated objectives and fundamentals that can lead to consistent rules and that prescribes the nature, function, and limits of financial accounting and financial statements.” The Need for Conceptual Framework - First, rulemaking should build on and relate to an established body of concepts and objectives; a soundly developed conceptual framework enables the FASB to issue more useful and consistent pronouncements over time o A coherent set of GAAP should result o Should increase user’s understanding of and confidence in financial reporting o Should enhance comparability among companies’ financial statements - Second, the profession should be able to more quickly solved new and emerging practical problems by referring to an existing framework of basic theory Development of a Conceptual Framework - FASB has issued 7 statements of financial accounting concepts 1) SFAC No. 1, “Objectives of Financial Reporting by Business Enterprises,” present goals and purpose of accounting 2) SFAC No. 2, “Qualitative Characteristics of Accounting Information,” examines the characteristics that make accounting information useful 3) SFAC No. 3, “Elements of Financial Statements of Business Enterprises,” provides definitions of items in financial statements, such as assets, liabilities, revenues, and expenses 4) SFAC No. 5, “Recognition and Measurement in Financial Statements of Business Enterprises,” sets forth fundamental recognition and measurement criteria and guidance on what information should be formally incorporated into financial statements and when 5) SFAC No. 6, “ Elements of Financial Statements,” replaces SFAC No. 3 and expands its scope to include not-for-profit organizations
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6) SFAC No. 7, “Using Cash Flow Information and Present Values in Accounting Measurements,” provides a framework for using expected future cash flows and present values as a basis for measurement - Illustration 2-1 - Accounting standards developed according to a conceptual framework will result in more useful accounting reports First Level: Basic Objectives - Objectives broadly concern information that is useful to investors and creditors - Companies prepare general-purpose financial statements Second Level: Fundamental Concepts - Second level provides conceptual building blocks that explain the qualitative characteristics of accounting information and define the elements of financial statements - Forms the bridge form why(1 st level) to how (3 rd level) Qualitative Characteristics of Accounting Information - Provide the most useful information for decision-making purposes (decision usefulness) - FASB identified the qualitative characteristics of accounting information that distinguish better (more useful) information from inferior (less useful) information for decision- making purposes - FASB also identified certain constraints (cost-benefit, materiality) as part of conceptual framework - Illustration 2.2
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