Chapter 002

Chapter 002 - Chapter 2 While we didn't spend much time in...

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Chapter 2 While we didn’t spend much time in class on this, you should have a working-knowledge of the conceptual framework in accounting. While some people persist in saying that GAAP is too “rules-based,” while IASB is “principles-based,” nothing could be further from the truth. The “rules” in GAAP are applications of the following principles to specific settings. If a specific transaction isn’t covered by GAAP, then one should use the principles and examples as a guide to best reflect the underlying economics of the transaction. First Level – the “why” – goals and purposes of accounting The objectives of accrual financial accounting are to provide information that is: 1. useful to those making investment and credit decisions who have a reasonable under- standing of business and economic activities (note – this could easily be expanded to in- clude individuals who wish to make employment decisions, consumers who wish to make purchases, and suppliers who wish to conduct business transactions with the firm and governments who want to determine the efficacy of various policies.) 2. helpful to present and potential investors, creditors, and others users in assessing the amounts, timing, and uncertainty of future cash flows (note – we use accrual accounting, instead of cash accounting, because accrual accounting does a better of job of forecasting future cash flows than cash accounting does), and 3. helpful in determining that amount of economic resources controlled or owned by the firm (i.e., assets), the claims on those resources (i.e., liabilities and owners’ equity), and changes in them (i.e., revenues and expenses). Second-Level - Qualitative Characteristics : acts as a bridge between the “why” and “how” of accounting- In order to provide useful information, it is necessary to think about how information should be presented – both in terms of the amount of information and the presentation format. For ex- ample, the accountant must make decisions about the level of aggregation of the financial data – should we have 50 line-items on the balance sheet – or should we simply report total assets, liab- ilities, and owners’ equity, or is something in between better? In the end, the answer to this question is largely a function of the accountant’s understanding of the target user(s) – That is, the accountant must understand the target user(s) - the decisions that the target user(s) makes, and the transactions s/he will undertake – in making decisions about the nature and amount of information to be disclosed. For example, when you want to communicate with someone, you want to speak in a common language. COMM 201 – Erickson/Wilkie Page 1
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Chapter 2 The FASB has identified two PRIMARY QUALITIES for financial reporting: 1. Relevance 2. Reliability With respect to relevance , the idea is that the information can affect user decisions – if the in- formation cannot affect the outcome of a user decision, then the information is irrelevant. Further, to be relevant, it must have
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Chapter 002 - Chapter 2 While we didn't spend much time in...

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