5-1 chapter 2: the conceptual framework chapter 2

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Chapter 2: The Conceptual Framework

CHAPTER 2CHAPTER 2

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Accounting theory provides a logical framework for accounting practice.

Structure of Accounting Theory Structure of Accounting Theory Formal ApproachFormal Approach

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Accounting theory provides a logical framework for accounting practice.

ASSUMPTIONS

Structure of Accounting Theory Structure of Accounting Theory FormalFormal ApproachApproach

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Accounting theory provides a logical framework for accounting practice.

ASSUMPTIONS

PRINCIPLES

Structure of Accounting Theory Structure of Accounting Theory FormalFormal ApproachApproach

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Accounting theory provides a logical framework for accounting practice.

ASSUMPTIONS

PRINCIPLES

RULES

Structure of Accounting Theory Structure of Accounting Theory FormalFormal ApproachApproach

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The Conceptual Framework The Conceptual Framework elementselements

Goals Assumptions Principles Information characteristics

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““Objectives of Financial Reporting By Business Objectives of Financial Reporting By Business Enterprises”Enterprises”

Report on enterprise resources, claims against resources and changes in them

Report economic resources, obligations and owners equity

Report enterprise performance and earnings

Evaluate liquidity, solvency, and flow of funds

Explain and interpret financial information

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Each business has an identity separate from its owners.

The business is the accounting entity. Financial statements report

only the activities, resources, and obligations of that business.

Each business has an identity separate from its owners.

The business is the accounting entity. Financial statements report

only the activities, resources, and obligations of that business.

AssumptionsAssumptions1-Business Entity “Idea”1-Business Entity “Idea”

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2-Going-Concern2-Going-Concern

In the absence of evidence to the contrary, we assume that a business will continue to exist indefinitely. For example, a company is more

likely to acquire long-term assets if it can assume that the company will continue to exist indefinitely.

It is fundamental to the matching principle.

In the absence of evidence to the contrary, we assume that a business will continue to exist indefinitely. For example, a company is more

likely to acquire long-term assets if it can assume that the company will continue to exist indefinitely.

It is fundamental to the matching principle.

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3-MONEY MEASUREMENT3-MONEY MEASUREMENT

Business entities measure economic events and transactions in monetary units. In the United States, the unit of

measurement is the dollar. In Jordan the unit of measurement is JD

Business entities measure economic events and transactions in monetary units. In the United States, the unit of

measurement is the dollar. In Jordan the unit of measurement is JD

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Assumes that the dollar maintains a relatively stable value. In countries with high inflation, this

assumption may not be valid.

Assumes that the dollar maintains a relatively stable value. In countries with high inflation, this

assumption may not be valid.

Stable Dollar orStable Dollar orStable Monetary UnitStable Monetary Unit

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Assumes that the dollar maintains a relatively stable value. In countries with high inflation, this

assumption may not be valid.

Accountants do not adjust the accounts for the changing value of the dollar (i.e., inflation)

Assumes that the dollar maintains a relatively stable value. In countries with high inflation, this

assumption may not be valid.

Accountants do not adjust the accounts for the changing value of the dollar (i.e., inflation)

Stable Dollar orStable Dollar orStable Monetary UnitStable Monetary Unit

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Continuous business activity is divided into arbitrary time periods as exemplified by this time line.

Business activity is best reported in annual, quarterly or monthly periods.

Continuous business activity is divided into arbitrary time periods as exemplified by this time line.

Business activity is best reported in annual, quarterly or monthly periods.

4-Periodicity4-Periodicity

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Substance Over Form The substance of a transaction or

economic event is more important than its legal form.

Main principlesMain principles

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principlesprinciples

Substance Over Form The substance of a transaction or

economic event is more important than its legal form.

e.g., next semester, we will study that even though parent and subsidiary companies are legally separate entities, GAAP says that a set of consolidated financial statements must be prepared as if they were one company, i.e., one economic entity.

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Other Major Principles/IdeasOther Major Principles/Ideas

Historical Cost MatchingRevenue RecognitionExpense RecognitionGain and Loss

RecognitionFull Disclosure

Historical Cost MatchingRevenue RecognitionExpense RecognitionGain and Loss

RecognitionFull Disclosure

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Historical Cost MatchingRevenue RecognitionExpense RecognitionGain and Loss

RecognitionFull Disclosure

Historical Cost MatchingRevenue RecognitionExpense RecognitionGain and Loss

RecognitionFull Disclosure

All transactions are recorded at their historical

cost at the time of the transaction.

All transactions are recorded at their historical

cost at the time of the transaction.

Major Principles/IdeasMajor Principles/Ideas

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Cost MatchingRevenue RecognitionExpense RecognitionGain and Loss

RecognitionFull Disclosure

Cost MatchingRevenue RecognitionExpense RecognitionGain and Loss

RecognitionFull Disclosure

The most important

principle. It provides the basis

for accrual accounting.

The most important

principle. It provides the basis

for accrual accounting.

Major Principles/IdeasMajor Principles/Ideas

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Exchange-Price or Historical Cost

MatchingRevenue RecognitionExpense RecognitionGain and Loss

RecognitionFull Disclosure

Exchange-Price or Historical Cost

MatchingRevenue RecognitionExpense RecognitionGain and Loss

RecognitionFull Disclosure

Revenues are recorded when they are earned (i.e., realized).

When does this happen?

When title passes.

Revenues are recorded when they are earned (i.e., realized).

When does this happen?

When title passes.

Major Principles/IdeasMajor Principles/Ideas

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Exceptions to Exceptions to Revenue Recognition PrincipleRevenue Recognition Principle

180 181

Cash basis of revenue recognition Installment basis of revenue recognition

(Need only know concept, not how to apply) Percentage-of-completion basis of

revenue recognition Revenue recognition at completion of

production(Need only know concept, not how to apply)

Cash basis of revenue recognition Installment basis of revenue recognition

(Need only know concept, not how to apply) Percentage-of-completion basis of

revenue recognition Revenue recognition at completion of

production(Need only know concept, not how to apply)

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Historical Cost MatchingRevenue RecognitionExpense RecognitionGain and Loss

RecognitionFull Disclosure

Historical Cost MatchingRevenue RecognitionExpense RecognitionGain and Loss

RecognitionFull Disclosure

Expenses should be recorded as

they are incurred in the process of

earning revenues.

Expenses should be recorded as

they are incurred in the process of

earning revenues.

Major Principles/IdeasMajor Principles/Ideas

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Historical Cost MatchingRevenue RecognitionExpense RecognitionGain and Loss

RecognitionFull Disclosure

Historical Cost MatchingRevenue RecognitionExpense RecognitionGain and Loss

RecognitionFull Disclosure

The rules are different for

recognition of gains and losses.

The rules are different for

recognition of gains and losses.

Major Principles/IdeasMajor Principles/Ideas

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Gain and Loss RecognitionGain and Loss Recognition

Gains are recognized/recorded at the time they are realized.

For example, an increase in the value of land cannot be recognized as a gain until the land is actually soldsold.

Gains are recognized/recorded at the time they are realized.

For example, an increase in the value of land cannot be recognized as a gain until the land is actually soldsold.

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Gain and Loss RecognitionGain and Loss Recognition

Gains are recognized/recorded at the time they are realized.

For example, an increase in the value of land cannot be recognized as a gain until the land is actually soldsold.

Losses are recognized when they become apparent.

For example, a decrease in the value of inventory would be recognized as a loss when it becomes apparent.

Gains are recognized/recorded at the time they are realized.

For example, an increase in the value of land cannot be recognized as a gain until the land is actually soldsold.

Losses are recognized when they become apparent.

For example, a decrease in the value of inventory would be recognized as a loss when it becomes apparent.

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MatchingRevenue RecognitionExpense RecognitionGain and Loss

RecognitionFull Disclosure

MatchingRevenue RecognitionExpense RecognitionGain and Loss

RecognitionFull Disclosure

Disclose in the financial

statements or related notes, all

information important enough

to influence a stakeholder.

Disclose in the financial

statements or related notes, all

information important enough

to influence a stakeholder.

Major Principles/IdeasMajor Principles/Ideas

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Cost-Benefit ConsiderationCost-Benefit Consideration

Optional information should be included in the primary financial statements only if the benefits of providing it

exceed the costs.

For example, providing a listing of every sales transaction may be

interesting, but the cost of providing that information to every shareholder

might bankrupt the company.

Optional information should be included in the primary financial statements only if the benefits of providing it

exceed the costs.

For example, providing a listing of every sales transaction may be

interesting, but the cost of providing that information to every shareholder

might bankrupt the company.

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8-Materiality8-Materiality

An item is material if knowledge of the item would affect the decision of an informed user, therefore, this is a somewhat nebulous concept.

Material items must be reported. An item can be material either in amount

or in nature.Materiality in amount is relative to the size of the amounts on a company’s fin. stmts.

(e.g. $50,000,000 may not be material …)

An item is material if knowledge of the item would affect the decision of an informed user, therefore, this is a somewhat nebulous concept.

Material items must be reported. An item can be material either in amount

or in nature.Materiality in amount is relative to the size of the amounts on a company’s fin. stmts.

(e.g. $50,000,000 may not be material …)

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9-Conservatism9-Conservatism

Transactions should be recorded so that net assets and net

income are not overstated.

Anticipate losses, but do not anticipate

gains.

Transactions should be recorded so that net assets and net

income are not overstated.

Anticipate losses, but do not anticipate

gains.

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““Qualitative Characteristics of Qualitative Characteristics of Accounting InformationAccounting Information

Addresses the question: What makes accounting information useful?

Develops a Hierarchy of Accounting Qualities

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5-30A Hierarchy of Accounting QualitiesA Hierarchy of Accounting Qualities

Users of Accounting Information

Pervasive Constraint

User-specific qualities

Primary Decision-specific

qualities

Ingredients of primary qualities

Secondary and interactive qualities

Threshold for recognition

Decision makers and their characteristics

(for example, understanding of prior knowledge

Benefits > Costs

Understandability

Decision Usefulness

Relevance Reliability

Timelines Verifiability Representationalfaithfulness

Predictive value

Feedback value

Neutrality

Comparability(including Consistency

Materiality30

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The Conceptual Framework The Conceptual Framework of the international accounting standards of the international accounting standards

committee ( IASC)committee ( IASC)

It Was formed in 1973 to develop worldwide accounting standards it was an independent private – sector body , whose objectives was to achieve uniformity in accounting principle that are used for worldwide financial reporting

The original board members of IASC were the accounting bodies of 9 countries :Australia, Canada, France, Japan, Mexico, Germany Netherlands, United Kingdom, United States

Objectives IASC 1973-20001. formulate and publish in the public interest accounting standards to

be observed in the presentation of financial statements and promote their worldwide acceptance and observance

2-work generally for the improvement and harmonization of regulations, accounting standards and procedures …

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From IASC to IASBFrom IASC to IASB

IASC Board IASB Board

volunteers, constituencies full-time, independent

approve IAS approve IFRS

Consultative Group Standards Advisory Council

Advisory Council TrusteesOversight , funding appoint Board oversight funding

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IASCIASC

The original board members of IASC were the accounting bodies of 9 countries

1) Australia 2) Canada 3) France4) Japan5) Mexico6) Netherlands 7) United Kingdom8) United States9) Germany

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Objectives Objectives IASC 1973-2005IASC 1973-2005

formulate and publish in the public interest accounting standards to be observed in the presentation of financial statements and promote their worldwide acceptance and observance

work generally for the improvement and harmonization of regulations, accounting standards and procedures …

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Overview of the Restructured IASBOverview of the Restructured IASB

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Components of the new structure: International Accounting Standards Board (IASB) – has sole responsibility for establishing International Financial Reporting Standards (IFRSs). IFRS Foundation (IFRSF) – oversees the work of the IASB, the structure, and strategy, and has fundraising responsibility. IASCF Monitoring Board – oversees the IFRSF Trustees, participates in the Trustee nomination process, and approves appointments to the Trustees. IFRS Interpretations Committee (IFRIC) – develops interpretations for approval by the IASB. IFRS Advisory Council (SAC) – advises the IASB and the IFRSF. Working Groups – expert task forces for individual agenda projects. *The Trustees announced that these name changes will be implemented as soon as practicable.

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Due process steps. Formal due process for projects normally, but not necessarily, involves the following steps. study national accounting requirements and practice and exchange views about the issues with national standard-setters;

consults the Standards Advisory Council about the advisability of adding the topic to the IASB's agenda; form an advisory group (generally called a 'working group') to advise the IASB and its staff on the project;

publish for public comment a discussion document;

publish for public comment an exposure draft approved by vote of at least nine IASB members, including any dissenting opinions held by IASB members (in exposure drafts, dissenting opinions are referred to as 'alternative views')

consider all comments received within the comment period on discussion documents and exposure drafts consider the desirability of holding a public hearing and the desirability of conducting field tests

Issue a final IFRS by at least votes of at least nine IASB members and include in the published standard any dissenting opinions;* and publish within a standard a basis for conclusions, explaining, among other things, the steps in the IASB's due process and how the IASB dealt with public comments on the exposure draft.

IFRS Due Process

IFRSF

IASB

IFRSC

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Use of IAS/IFRSUse of IAS/IFRS

IAS as national standards Croatia, Cyprus, Jordan, Kuwait, Romania, Nepal

Serbia, peru EU from 2005

IAS as basis for national standards China, Denmark, Switzerland,

Harmonisation/convergence projects Australia, USA, Japan, Hong Kong, South Africa,

Sweden, UK, Egypt