Conceptual Framework Elements Recognition & Measurement Concepts Recognition & Measurement Concepts Assumptions, Principles & Concepts Assumptions, Principles.
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Conceptual Framework ElementsRecognition & Measurement ConceptsAssumptions, Principles & Concepts Financial Statements / Financial ReportingObjectives
Objectives of Financial Reporting by Business Enterprises: User PerspectiveFinancial reporting should provide:(1) information useful in investment & credit decisions(2) information useful in assessing cash flow prospect (amount, timing & uncertainty), &(3) information about enterprise resources, claims to those resources, & changes therin.*** ... individuals who have a reasonable understanding of business & economic activities & are willing to study the information with reasonable diligence.SFAC 1
Qualitative CharacteristicsPrimary Qualities:(1) Relevance(a) Predictive value,(b) Feedback value &(c) Timeliness(2) Reliability(a) Verifiability(b) Representational Faithfulness(c) NeutralitySecondary Qualities:(1) Comparability (across firms)(2) Consistency (over time)SFAC 2
Elements of Financial StatementsAssetsLiabilitiesEquityInvestments by OwnersDistributions to OwnersComprehensive Income RevenueExpensesGainsLosses
Recognition & Measurement ConceptsAssumptionsEconomic EntityGoing ConcernMonetary UnitPeriodocityPrinciplesHistorical CostRevenue RecognitionMatchingFull disclosureConstraintsCost-BenefitsMaterialityIndustry PracticeConservatism
Accounting Assumptions:Economic Entity: The business or economic entity exists separate & distinct from its owners, employees, suppliers & customers. This assumption defines accounting boundaries, but not legal boundaries.Going Concern: General purpose accounting reports are constructed under the assumption that the business enterprise will continue in business for the foreseeable future. The current relevance of the historical cost principle is based on the going-concern assumption.Monetary Unit: Economic activity of an entity are measured and reported in the U.S. dollar. This assumes that the dollar has a reasonably constant value over time in terms of purchasing power. This assumption ignores inflation.Periodocity: Assumes that the economic life of a business can be divided into discrete time periods and that financial reports from each period are interpretable.
Historical Cost PrincipleAcquisition cost is the most objective and verifiable basis upon which to account for assets and liabilities. That is, it is reliable.
5 methods to measure assets & liabilities:Historical costCurrent costCurrent market valueNet realizable (settlement) valuePresent (discounted) value
Revenue Recognition PrincipleRecognize Revenue when:(a) realized or realizable & (b) earned.on the date of saleexceptions:(a) during production ... if the production process is long Ex: long-term construction contract(b) end of production if selling price & amount is certain ex: mining of certain minerals(c) receipt of cash if the amount to be collected is uncertain
RecognitionRevenuewhen realized or realizable & earnedGains when realized or realizableExpenses .when economic benefits are consumed in revenue-earning activities or when future economic benefits are reduced or eliminatedLosses ..when future economic benefits are reduced or eliminatedSFAC 5
Matching Principle Expenses are matched to the revenue generated in that accounting period
let the expenses follow the revenues
Full Disclosure PrincipleFinancial statements should include sufficient information to permit the knowledgeable reader to make an informed judgment about the financial condition of the enterprise.
trade-offs:-sufficient detail to make a difference-presented in a condensed form for understandability & to avoid information overload
Constraints:Cost-Benefit: The cost of providing the information should not exceed the benefits that can be derived from the information.
Materiality: An item is material if its inclusion or omission would influence or change the judgment of a reasonable man. Materiality is based on relative size & importance.
Industry Practice: The unique nature of some industries and business concerns sometimes (rarely) requires departure from basic theory.
Conservatism: Never overstate assets or income.
Financial Statements show:Statement of Financial PositionEarningsComprehensive Earnings (earnings adjusted for the cumulative adjustment or other nonowner changes in equity foreign currency translation)Cash FlowsTransactions with Owners
A Hierarchy of Accounting QualitiesSFAC 2 Decision Makers Materiality Users ofAccounting InformationPervasiveContraint User SpecificQualitiesPrimary QualitiesPrimary Qualities
Secondary QualitiesThreshold forRecognitionBenefits > CostsRelevance Reliability Predictive Feedback Time- Verifi- Neutral- Representational Value Value liness ability ity Faithfulness Comparability ConsistencyUnderstandability