1 financial reporting: its conceptual framework financial reporting: its conceptual framework c...
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Financial Reporting:
Its Conceptual Framework
Financial Reporting:
Its Conceptual Framework
Chapter2
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Explain the FASB conceptual framework. Understand the relationship among the
objectives of financial reporting. Identify the general objective of financial
reporting. Describe the three specific objectives of
financial reporting.
ObjectivesObjectives
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Discuss the types of useful information for investment and credit decision making.
Explain the qualities of useful accounting information.
Understand the accounting assumptions and conventions that influence GAAP.
Define the elements of financial statements.
ObjectivesObjectives
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Charges Given to the FASBCharges Given to the FASB
To develop a conceptual
framework of accounting theory.
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Charges Given to the FASBCharges Given to the FASB
To establish standards (GAAP)
for financial accounting practices.
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FASB Conceptual FrameworkFASB Conceptual Framework
• To guide the FASB in establishing accounting standards.
• To provide a frame of reference for resolving accounting questions in situations where a standard does not exist.
• To determine the bounds for judgment in the preparation of financial statements.
• To increase users’ understanding of and confidence in financial reporting.
• To enhance comparability.
• To guide the FASB in establishing accounting standards.
• To provide a frame of reference for resolving accounting questions in situations where a standard does not exist.
• To determine the bounds for judgment in the preparation of financial statements.
• To increase users’ understanding of and confidence in financial reporting.
• To enhance comparability.
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Relationship of Conceptual Framework and Standard-Setting Process
Relationship of Conceptual Framework and Standard-Setting Process
Conceptual Framework
Objectives and ConceptsObjectives and ConceptsTerms
Identify goals and Identify goals and purpose of accountingpurpose of accounting
Guide the selection of events to Guide the selection of events to be accounted for, the be accounted for, the
measurement of these events, and measurement of these events, and the means of summarizing and the means of summarizing and communicating the information communicating the information
to external users,to external users,
Purpose
Statements of Financial Statements of Financial Accounting ConceptsAccounting Concepts
Documents
to standard setting
to standard setting
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Relationship of Conceptual Framework and Standard-Setting Process
Relationship of Conceptual Framework and Standard-Setting Process
Standard Setting
Statements of Financial Accounting Standards
Standards
Establish methods and procedures for measuring,
summarizing, and communicating financial accounting information to
external users.
From conceptual framework
From conceptual framework
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Conceptual Framework Projects for Financial Accounting and ReportingConceptual Framework Projects for Financial Accounting and Reporting
Objective Objective ProjectProject
Accounting Accounting ProjectsProjects
Reporting Reporting ProjectsProjects
continued continued continued
Qualitative Characteristics Qualitative Characteristics ProjectProject
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Conceptual Framework Projects for Financial Accounting and ReportingConceptual Framework Projects for Financial Accounting and Reporting
Accounting Accounting ProjectsProjects
Reporting Reporting ProjectsProjects
Qualitative Characteristics Qualitative Characteristics ProjectProject
Elements
Recognition
Measurement
Financial Statements and Financial
Reporting
Income
Cash Flow and Liquidity
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Objectives of Financial ReportingObjectives of Financial Reporting
Provide information that is useful to present and potential investors, creditors, and other
users in making rational investment, credit, and similar
decisions.
General Objective
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Objectives of Financial ReportingObjectives of Financial Reporting
Provide information that is useful to present and potential investors
creditors, and other users in assessing the amounts, timing, and
uncertainty of prospective cash receipts from dividends and interest,
and the proceeds from the sale, redemption, or maturity of securities
or loans.
Derived External User Objective
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Objectives of Financial ReportingObjectives of Financial Reporting
Provide information to help investors, creditors, and others in
assessing the amounts, timing, and uncertainty of prospective
net cash inflows to related company.
Derived Company Objective
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Objectives of Financial ReportingObjectives of Financial Reporting
Specific Objectives
Provide information about a company’s economic resources, obligations, and owners’ equity.
Provide information about a company’s economic resources, obligations, and owners’ equity.
Provide information about a company’s comprehensive income and its components.
Provide information about a company’s comprehensive income and its components.
Provide information about a company’s
cash flows.
Provide information about a company’s
cash flows.
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Other IssuesOther Issues
First, financial reporting should provide information about how the management of a company has discharged its stewardship
responsibility.
First, financial reporting should provide information about how the management of a company has discharged its stewardship
responsibility.
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Other IssuesOther Issues
Second, financial statements and other means of financial
reporting should include explanations and interpretations
by management to help external users.
Second, financial statements and other means of financial
reporting should include explanations and interpretations
by management to help external users.
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Other IssuesOther Issues
Third, the FASB made no decision concerning the
qualitative characteristics that accounting information should possess in order to be included
in financial reports.
Third, the FASB made no decision concerning the
qualitative characteristics that accounting information should possess in order to be included
in financial reports.
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Objectives in Other CountriesObjectives in Other Countries
German accounting principles are affected by
legal and income tax requirements. German accounting emphasizes
information for creditors and has a conservative
balance sheet orientation.
German accounting principles are affected by
legal and income tax requirements. German accounting emphasizes
information for creditors and has a conservative
balance sheet orientation. German
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Objectives in Other CountriesObjectives in Other Countries
Swedish companies use “income smoothing” in their financial statements to make profits seem uniform from
year to year. Some consider such income smoothing to
contribute to economic stability.
Swedish companies use “income smoothing” in their financial statements to make profits seem uniform from
year to year. Some consider such income smoothing to
contribute to economic stability.
Sweden
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Objectives in Other CountriesObjectives in Other Countries
In France, accounting rules In France, accounting rules essentially are controlled by essentially are controlled by law and are influenced by law and are influenced by
income tax rules. The income tax rules. The French legal system makes French legal system makes the officers of a company the officers of a company
personally responsible, to a personally responsible, to a great extent, for the great extent, for the
consequences of business consequences of business bankruptcy.bankruptcy.
In France, accounting rules In France, accounting rules essentially are controlled by essentially are controlled by law and are influenced by law and are influenced by
income tax rules. The income tax rules. The French legal system makes French legal system makes the officers of a company the officers of a company
personally responsible, to a personally responsible, to a great extent, for the great extent, for the
consequences of business consequences of business bankruptcy.bankruptcy.
France
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Interrelationship of Final Reports, Useful Information, and Decision Making
Interrelationship of Final Reports, Useful Information, and Decision Making
Financial Reports
Return on Investment
Risk
Financial Flexibility
Liquidity
Operating Capability
Buy Hold Sell
Extend Continue
Deny (Credit)
Communication Documents
Types of Useful Information
External Decision Making
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RelevanceRelevance RelevanceRelevance
Hierarchy of Qualitative CharacteristicsHierarchy of Qualitative Characteristics
Accounting Information
Benefits>CostsBenefits>Costs
Understandability
Decision Usefulness
Pervasive Pervasive ConstraintConstraint
Pervasive Pervasive ConstraintConstraint
User-User-Specific Specific QualityQuality
User-User-Specific Specific QualityQualityOverall Overall QualityQuality
Overall Overall QualityQuality
Primary Decision-Specific QualitiesPrimary Decision-Specific Qualities
Continued next slide
Continued next slide
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Ingredients of Primary QualitiesIngredients of Primary Qualities
RelevanceRelevance RelevanceRelevance
Hierarchy of Qualitative CharacteristicsHierarchy of Qualitative Characteristics
Predictive Value
Feedback Value
Timeli-ness
Verifi-ability
Representa-tional
faithfulness
Neu-trality
Secondary Secondary and and
Interactive Interactive QualitiesQualities
MaterialityMateriality
Comparability (including Consistency
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Hierarchy of Qualitative CharacteristicsHierarchy of Qualitative Characteristics
Accounting information is relevant if it can make a difference in a decision.
Accounting information is relevant if it can make a difference in a decision.
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Hierarchy of Qualitative CharacteristicsHierarchy of Qualitative Characteristics
Accounting information is reliable when it is reasonably free from error and bias, and faithfully represents what it is
intended to represent.
Accounting information is reliable when it is reasonably free from error and bias, and faithfully represents what it is
intended to represent.
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Hierarchy of Qualitative CharacteristicsHierarchy of Qualitative Characteristics
Comparability of accounting information enables users to
identify and explain similarities and differences between two or
more sets of economic facts.
Comparability of accounting information enables users to
identify and explain similarities and differences between two or
more sets of economic facts.
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Constraints to the HierarchyConstraints to the Hierarchy
Are benefits greater
than costs?
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• The nature of the item.
• The relative size rather than absolute size of an item.
• The nature of the item.
• The relative size rather than absolute size of an item.
Constraints to the HierarchyConstraints to the Hierarchy
Materiality
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Assumptions and ConventionsAssumptions and Conventions
EntityEntity
The entity assumption assumes that a proprietorship, partnership, or corporation’s financial activities are distinguished from other financial organizations in keeping its
own financial records and reports.
The entity assumption assumes that a proprietorship, partnership, or corporation’s financial activities are distinguished from other financial organizations in keeping its
own financial records and reports.
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Assumptions and ConventionsAssumptions and Conventions
ContinuityContinuity
This assumption assumes that the company will continue to operate in the near future, unless substantial evidence to the contrary
exists. This assumption is also known as the going-concern assumption.
This assumption assumes that the company will continue to operate in the near future, unless substantial evidence to the contrary
exists. This assumption is also known as the going-concern assumption.
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Assumptions and ConventionsAssumptions and Conventions
Period of TimePeriod of Time
In accordance with the period-of-time assumption, a company prepares financial
statements at the end of each year and includes them its annual report. The period-
of-time assumption is the basis for the adjusting entry process at period-end.
In accordance with the period-of-time assumption, a company prepares financial
statements at the end of each year and includes them its annual report. The period-
of-time assumption is the basis for the adjusting entry process at period-end.
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Assumptions and ConventionsAssumptions and Conventions
Historical CostHistorical Cost
Usually, the exchange price is retained in the accounting records as the value of an item
until it is removed from the records.
Usually, the exchange price is retained in the accounting records as the value of an item
until it is removed from the records.
Cost$16,000
Cost$16,000
Replacement Cost
$13,000
Replacement Cost
$13,000
Market Value
$13,500
Market Value
$13,500
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Assumptions and ConventionsAssumptions and Conventions
Historical CostHistorical Cost
Which amount Which amount should be used?should be used?Which amount Which amount should be used?should be used?
Cost$16,000
Cost$16,000
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Assumptions and ConventionsAssumptions and Conventions
Monetary UnitMonetary Unit
This assumption states that there must be some basis for measuring exchange of goods
or services. Currently the dollar is considered to be a stable monetary unit for
preparing a company’s financial statements.
This assumption states that there must be some basis for measuring exchange of goods
or services. Currently the dollar is considered to be a stable monetary unit for
preparing a company’s financial statements.
The FASB encourages The FASB encourages companies to prepare companies to prepare
supplemental disclosures about supplemental disclosures about the impact of changing prices.the impact of changing prices.
The FASB encourages The FASB encourages companies to prepare companies to prepare
supplemental disclosures about supplemental disclosures about the impact of changing prices.the impact of changing prices.
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Assumptions and ConventionsAssumptions and Conventions
Realization and RecognitionRealization and Recognition
Realization is the process of converting noncash resources and rights into cash or
rights to cash. Recognition is the process of formally recording and reporting an item in
the financial statements of a company.
Realization is the process of converting noncash resources and rights into cash or
rights to cash. Recognition is the process of formally recording and reporting an item in
the financial statements of a company.
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Assumptions and ConventionsAssumptions and Conventions
Matching and Accrual AccountingMatching and Accrual Accounting
Accrual accounting is the process of relating the financial effects of transactions, events,
and circumstances having cash consequences to the period in which they occur rather than to when the cash receipt or payment occurs.
Accrual accounting is the process of relating the financial effects of transactions, events,
and circumstances having cash consequences to the period in which they occur rather than to when the cash receipt or payment occurs.
The matching principle states that to determine the income of a company for an accounting
period, the company computes the total expense involved in obtaining the revenues of the period and relates these total expenses to
the total revenues recorded in the period.
The matching principle states that to determine the income of a company for an accounting
period, the company computes the total expense involved in obtaining the revenues of the period and relates these total expenses to
the total revenues recorded in the period.
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Assumptions and ConventionsAssumptions and Conventions
ConservatismConservatism
The Conservatism convention states that when alternative accounting valuations are
equally possible, the accountant should select the one that is least likely to overstate assets
and income in the current period.
The Conservatism convention states that when alternative accounting valuations are
equally possible, the accountant should select the one that is least likely to overstate assets
and income in the current period.
Click here to review assumptions and conventions (C2-2)
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Balance SheetBalance Sheet
A balance sheet is a financial statement that
summarizes the financial position of a company on a
particular date.
A balance sheet is a financial statement that
summarizes the financial position of a company on a
particular date.
It also is called a statement of
financial position.
It also is called a statement of
financial position.
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Assets are the probable future economic benefits obtained and controlled by a company as a result of past transactions or events.
Liabilities are the probable future sacrifices of economic benefits arising from present obligations of a company to transfer assets or provide services in the future as a result of past transactions or events.
Equity is the owners’ residual interest in the net assets of a company.
Balance SheetBalance SheetElements of a balance sheet:
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Income StatementIncome Statement
An income statement is a financial statement that
summarizes the results of a company’s operations.
An income statement is a financial statement that
summarizes the results of a company’s operations.
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Revenues are inflows or other enhancements of assets of a company or settlement of its liabilities during a period from delivering or producing goods, rendering services, or other activities that are the company’s ongoing major operation.
Expenses are outflows or other using up of assets of a company or incurrences of liabilities during a period that are the company’s ongoing major operation.
Income StatementIncome Statement
The elements of the income statement are:
Continued on next slideContinued on next slide
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Gains are increases in equity from peripheral or incidental transactions of a company and from all other transactions and other events and circumstances affecting the company, except those that result from revenues or investments by owners.
Losses are decreases in equity from peripheral or incidental transactions of a company, except those that result from expenses or distribution to owners.
Income StatementIncome Statement
The elements of the income statement are:
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Income StatementIncome Statement
Revenues increase the equity of the
company
Expenses decrease the equity of the
company
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Statement of Cash FlowsStatement of Cash Flows
A statement of cash flows summarizes the cash
inflows and outflows of a company for a period.
A statement of cash flows summarizes the cash
inflows and outflows of a company for a period.
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Operating cash flows are the flows of cash from acquiring, selling, and delivering goods for sale, as well as providing services.
Investing cash flows are the flows of cash from acquiring and selling investments, property, plant, and equipment, as well as from lending money and collecting on loans.
Financing cash flows are the flows of cash to and from the owners and long-term creditors.
Statement of Cash FlowsStatement of Cash FlowsThe elements of a statement of cash flows are:
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Statement of Changes in EquityStatement of Changes in Equity
A statement of changes in equity summarizes the
changes in a company’s equity for a period.
A statement of changes in equity summarizes the
changes in a company’s equity for a period.
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Investments by owners are increases in equity resulting from transfers of something valuable to the company from other entities in order to obtain or increase ownership interest.
Distribution to owners are decreases in equity of a company caused by transferring assets, rendering services, or incurring liabilities to owners.
Statement of Changes in EquityStatement of Changes in EquityA statement of changes in equity contains two elements:
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Business ReportingBusiness Reporting
Financial and nonfinancial data. Management’s analysis of the financial and
nonfinancial data. Forward-looking information. Information about management and
shareholders. Background about the company.
Financial and nonfinancial data. Management’s analysis of the financial and
nonfinancial data. Forward-looking information. Information about management and
shareholders. Background about the company.
Framework of the Model
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Chapter2
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C 2-2: Identify the assumption or convention
C 2-2: Identify the assumption or convention
The business, rather than its owners, is the reporting unit.
EntityEntity
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C 2-2: Identify the assumption or convention
C 2-2: Identify the assumption or convention
Depreciation costs are expensed in the periods of use rather than at the time the asset is acquired.
MatchingMatching
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C 2-2: Identify the assumption or convention
C 2-2: Identify the assumption or convention
Accounting measurements are reported in dollars.
Monetary unitMonetary unit
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C 2-2: Identify the assumption or convention
C 2-2: Identify the assumption or convention
The year is the normal reporting unit.
Period of timePeriod of time
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C 2-2: Identify the assumption or convention
C 2-2: Identify the assumption or convention
In the absence of evidence to the contrary, the business will operate long enough to carry out its existing commitments.
ContinuityContinuity
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C 2-2: Identify the assumption or convention
C 2-2: Identify the assumption or convention
Revenue is usually recognized at the time of sale.
RealizationRealization
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C 2-2: Identify the assumption or convention
C 2-2: Identify the assumption or convention
Exchange price is retained in the accounting records.
Historical costHistorical cost
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C 2-2: Identify the assumption or convention
C 2-2: Identify the assumption or convention
An accounting alternative is selected that is least likely to overstate assets and income.
ConservatismConservatism
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