document2
TRANSCRIPT
1
Financial Financial Reporting: Reporting:
Its Conceptual Its Conceptual FrameworkFramework
Financial Financial Reporting: Reporting:
Its Conceptual Its Conceptual FrameworkFramework
Chapter2
An electronic presentation by Douglas Cloud
Pepperdine University
An electronic presentation by Douglas Cloud
Pepperdine University
2
1. Explain the FASB conceptual framework.
2. Understand the relationship among the objectives of financial reporting.
3. Identify the general objective of financial reporting.
4. Describe the three specific objectives of financial reporting.
ObjectivesObjectivesObjectivesObjectives
ContinuedContinuedContinuedContinued
3
5. Discuss the types of useful information for investment and credit decision making.
6. Explain the qualities of useful accounting information.
7. Understand the accounting assumptions and conventions that influence GAAP.
8. Define the elements of financial statements.
ObjectivesObjectives
4
Charges Given to the FASBCharges Given to the FASBCharges Given to the FASBCharges Given to the FASB
To develop a conceptual
framework of accounting theory.
5
Charges Given to the FASBCharges Given to the FASBCharges Given to the FASBCharges Given to the FASB
To establish standards (GAAP)
for financial accounting practices.
6
FASB Conceptual FrameworkFASB Conceptual FrameworkFASB 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.
7
Relationship of Conceptual Framework Relationship of Conceptual Framework and Standard-Setting Processand Standard-Setting Process
Relationship of Conceptual Framework Relationship of Conceptual Framework and Standard-Setting Processand 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 ContinuedContinuedContinuedContinued
8
Relationship of Conceptual Framework Relationship of Conceptual Framework and Standard-Setting Processand Standard-Setting Process
Relationship of Conceptual Framework Relationship of Conceptual Framework and Standard-Setting Processand 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 Objectives
and Concepts
Statements of Financial
Accounting Concepts
9
Conceptual Framework Projects for Conceptual Framework Projects for Financial Accounting and ReportingFinancial Accounting and ReportingConceptual Framework Projects for Conceptual Framework Projects for Financial Accounting and ReportingFinancial Accounting and Reporting
Objective Project
Accounting Projects
Reporting Projects
continued continued continued
Qualitative Characteristics Project
10
Accounting Projects
Reporting Projects
Qualitative Characteristics Project
Conceptual Framework Projects for Conceptual Framework Projects for Financial Accounting and ReportingFinancial Accounting and ReportingConceptual Framework Projects for Conceptual Framework Projects for Financial Accounting and ReportingFinancial Accounting and Reporting
Elements
Recognition
Measurement
Financial Statements and Financial
Reporting
Income
Cash Flow and Liquidity
11
Objectives of Financial ReportingObjectives of Financial ReportingObjectives 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
12
Objectives of Financial ReportingObjectives of Financial ReportingObjectives 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
13
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
Objectives of Financial ReportingObjectives of Financial ReportingObjectives of Financial ReportingObjectives of Financial Reporting
14
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.
Objectives of Financial ReportingObjectives of Financial ReportingObjectives of Financial ReportingObjectives of Financial Reporting
15
Other IssuesOther IssuesOther IssuesOther Issues
First, financial reporting should provide information about how the management
of a company has discharged its stewardship
responsibilities.
First, financial reporting should provide information about how the management
of a company has discharged its stewardship
responsibilities.
16
Second, financial statements and other means of financial reporting should include explanations and interpretations to management to help external users understand the
financial information provided.
Second, financial statements and other means of financial reporting should include explanations and interpretations to management to help external users understand the
financial information provided.
Other IssuesOther IssuesOther IssuesOther Issues
17
Providing this critical information is known as
full disclosure.
Providing this critical information is known as
full disclosure.
Other IssuesOther IssuesOther IssuesOther Issues
18
Interrelationship of Final Reports, Useful Interrelationship of Final Reports, Useful Information, and Decision MakingInformation, and Decision Making
Interrelationship of Final Reports, Useful Interrelationship of Final Reports, Useful Information, and Decision MakingInformation, and Decision Making
Financial Reports
Return on Investment
Risk
Financial Flexibility
Liquidity
Operating Capability
Buy Hold Sell
Extend CreditContinue
CreditDeny Credit
Communication Documents
Types of Useful Information External Decision Making
19
Relevance Reliability
Hierarchy of Qualitative CharacteristicsHierarchy of Qualitative CharacteristicsHierarchy 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 QualityQuality
Primary Decision-Specific QualitiesPrimary Decision-Specific QualitiesContinuedContinuedContinuedContinued
Overall Overall QualityQuality
Overall Overall QualityQuality
20
Ingredients of Primary QualitiesIngredients of Primary Qualities
RelevanceRelevance ReliabilityReliability
Hierarchy of Qualitative CharacteristicsHierarchy of Qualitative CharacteristicsHierarchy of Qualitative CharacteristicsHierarchy of Qualitative Characteristics
Predictive Value
Feedback Value
Timeli-ness
Verifi-ability
Representa-tional
faithfulness
Neu-trality
Secondary and
Interactive Qualities
MaterialityMateriality
Comparability (including Consistency
Threshold for
Recognition
21
Hierarchy of Qualitative CharacteristicsHierarchy of Qualitative CharacteristicsHierarchy 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.
22
Hierarchy of Qualitative CharacteristicsHierarchy of Qualitative CharacteristicsHierarchy 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.
23
Hierarchy of Qualitative CharacteristicsHierarchy of Qualitative CharacteristicsHierarchy 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.
24
Constraints to the HierarchyConstraints to the HierarchyConstraints to the HierarchyConstraints to the Hierarchy
Are benefits greater
than costs?
25
• 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 HierarchyConstraints to the HierarchyConstraints to the Hierarchy
Materiality
26
Assumptions and ConventionsAssumptions and ConventionsAssumptions 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.
27
Assumptions and ConventionsAssumptions and ConventionsAssumptions 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.
28
Assumptions and ConventionsAssumptions and ConventionsAssumptions 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.
29
Assumptions and ConventionsAssumptions and ConventionsAssumptions 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
30
Assumptions and ConventionsAssumptions and ConventionsAssumptions 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
31
Assumptions and ConventionsAssumptions and ConventionsAssumptions 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 supplemental disclosures about the impact of about the impact of
changing prices.changing prices.
The FASB encourages The FASB encourages companies to prepare companies to prepare
supplemental disclosures supplemental disclosures about the impact of about the impact of
changing prices.changing prices.
32
Assumptions and ConventionsAssumptions and ConventionsAssumptions 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.
33
Assumptions and ConventionsAssumptions and ConventionsAssumptions 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.
34
Assumptions and ConventionsAssumptions and ConventionsAssumptions 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.
35
Balance SheetBalance SheetBalance 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.
36
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 SheetBalance SheetBalance SheetElements of a balance sheet:
37
Income StatementIncome StatementIncome 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.
38
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. Revenues increase the equity of a company.
Income StatementIncome StatementIncome StatementIncome Statement
ContinuedContinuedContinuedContinued
The elements of the income statement are:
39
Expenses are outflows or other using up of assets of a company or incurrences of liabilities during a period from delivering or producing goods, rendering services, or carrying out other activities that are the company’s ongoing major operation. Expenses decrease the equity of a company.
Income StatementIncome StatementIncome StatementIncome Statement
ContinuedContinuedContinuedContinued
The elements of the income statement are:
40
Gains are increases in the equity of a company from peripheral or incidental transactions and from all other transactions and other events and circumstances affecting the company, except those that result from revenues or investments by owners. Gains increase the equity of a company.
Income StatementIncome StatementIncome StatementIncome Statement
ContinuedContinuedContinuedContinued
The elements of the income statement are:
41
Losses are decreases in the equity of a company, from peripheral or incidental transactions except those that result from expenses or distribution to owners. Losses decrease the equity of a company.
Income StatementIncome StatementIncome StatementIncome Statement
The elements of the income statement are:
42
Income StatementIncome StatementIncome StatementIncome Statement
Revenues increase the equity of the
company
Expenses decrease the equity of the
company
43
Statement of Cash FlowsStatement of Cash FlowsStatement of Cash FlowsStatement of Cash Flows
A statement of cash flows is a financial statement that summarizes the cash inflows and outflows of a
company for a period.
A statement of cash flows is a financial statement that summarizes the cash inflows and outflows of a
company for a period.
44
o Operating cash flows are the flows of cash from acquiring, selling, and delivering goods for sale, as well as providing services.
o 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.
o Financing cash flows are the flows of cash to and from the owners and long-term creditors.
Statement of Cash FlowsStatement of Cash FlowsStatement of Cash FlowsStatement of Cash FlowsThe elements of a statement of cash flows are:
45
Statement of Changes in EquityStatement of Changes in EquityStatement 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.
46
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 EquityStatement of Changes in EquityStatement of Changes in EquityA statement of changes in equity contains two elements:
47
Model of Business ReportingModel of Business ReportingModel of Business ReportingModel of Business Reporting
1. Financial and nonfinancial data.
2. Management’s analysis of the financial and nonfinancial data.
3. Forward-looking information.
4. Information about management and shareholders.
5. Background about the company.
1. Financial and nonfinancial data.
2. Management’s analysis of the financial and nonfinancial data.
3. Forward-looking information.
4. Information about management and shareholders.
5. Background about the company.
Framework of the Model
48
Chapter2
The EndThe EndThe EndThe End