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Chapter 1
The Conceptual Framework and Objectives of Financial Reporting
What is Accounting Used For?
• Decision Making– Evaluation of past performance– Expectations of future performance
• Allocation of Resources
Free enterprise principle
Resources will flow to the segments of the economy
that will use them most efficiently in the creation of new wealth
Role of Accounting
Accounting Information
Investors
Chapter 1 -- Learning Objective
2. Trace the evolution of generally accepted accounting
principles
GAAP
GAAP
A consensus
The conventions, rules, and procedures necessary to define accepted accounting
practice
Sources of GAAP
Committee on Accounting ProceduresAccounting Principles BoardFinancial Accounting Principles Board
Committee on Accounting Procedure
CAP1939 - 1959
First private body concerned with writing accounting rules
Issued 51 Accounting Research BulletinsMembers were practicing CPAsAn “ad hoc” approach
Accounting Principles Board
APB1959 - 1973
Appointed by the AICPAPrimarily from public accountingIssued 31 APB OpinionsCriticized for failing to deal with
problems on a timely basis Many saw a need for independence
Financial Accounting Foundation
FAF Established 1973
Appoints members of Financial Accounting Standards Board (FASB)
Appoints members of Financial Accounting Standards Advisory Committee (FASAC)
Provides financial support to FASBContributions from industry & CPA firms
Financial Accounting Standards Board
FASB Established 1973
7 membersMembers are full time, well paidResponsible only to FAFPassage of standards requires 5 out of 7
votes
Securities and Exchange Commission
• Appointed by President
• Reports to Congress
• Final authority on reporting by public companies
International Accounting Standards
• International Accounting Standards Committee
• Standards less specific
• “Principle Based”
• Not allowed by SEC
Accounting Standard Setting
• A political process
Chapter 1 -- Learning Objective
3. Relate the objectives of financial reporting as stated in the
conceptual framework to the accounting process
Conceptual Framework
Statements of Financial Accounting Concepts (SFACs)
Purpose:Establish the objectives and concepts to be used by the FASB in developing standards for financial reporting
Conceptual Framework
SFACs
1 Objectives of Financial Reporting
2 Qualitative Characteristics
4 Objectives for Nonbusiness Organizations
5 Recognition & Measurement
6 Elements of Financial Statements
Objectives of Financial Reporting
SFAC No. 1
To provide information:
1.Useful in investment and credit decisions
2.Useful in assessing future cash flows
3.About enterprise resources, claims and changes
Chapter 1 -- Learning Objective
4. Interpret the meaning of the qualitative characteristics of
accounting information enumerated in the conceptual framework
Objectives
• Useful for decision making• Information about future cash flows• Information about resources, claims to
resources, changes in resources– Liquidity– Solvency– Flexibility– Profitability
Qualitative Characteristics
SFAC No. 2
� Primary Qualities� Understandability* Relevance* Reliability
� Secondary Qualities* Comparability* Consistency
RelevanceThe capacity for information to make a difference
Predictive Value
Feedback Value
Timeliness
ReliabilityUser has confidence in the information:
Verifiability
Representational Faithfulness
Neutrality
Secondary Qualities
• Comparability—With other enterprises
• Consistency—Period to Period– Changes in accounting must be to Better
principles
ConstraintsMeasurement and reporting practices are affected by:
Cost/benefits
Materiality
Industry practices
Chapter 1 -- Learning Objective
5. Understand the assumptions and conventions underlying the
recognition and measurement of accounting data for financial reporting
Recognition and Measurement
SFAC No. 5
� Recognition* Reporting an item in the financial statements
� Measurement* The amount reported for an item in financial
statements
Recognition Criteria1 Definition
� Must meet definition of an element of financial statements found in SFAC No. 6
2 Measurability� Must be measurable with sufficient reliability
3 Relevance� Must be capable of making a difference
4 Reliability� Must be representationally faithful, verifiable & neutral
Basic Accounting Assumptions:
Economic entity
Going concern (Continuity)
Periodicity
Monetary unit
Basic Conventions and Practices
Cost or other measurement attributes
Revenue recognition
Matching
Conservatism
Full disclosure
Chapter 1 -- Learning Objective
6. Distinguish among the elements of the financial statements
Elements of Financial StatementsSFAC No. 6
Basic Building Blocks
Elements of Financial Statements• Assets
• Liabilities
• Equity
• Investments by owners
• Distributions to owners
• Comprehensive Income
• Revenues
• Expenses
• Gains
• Losses
Balance Sheet
Income Statement
Chapter 1 -- Learning Objective
7. Understand how accounting information is used in
investment decision models
Investment Decision Model
Growth potential
Goal
FactorsOperating efficiency
Capital generation
Asset productivity
Financial leverage
Income Statement
Balance Sheet
Chapter 1 -- Learning Objective
8. Develop an appreciation of ethical and moral considerations in
business
Decision Model
1. Determine the Facts
2. Define the ethical issues
3. Identify major values
4. Specify the Alternatives
5. Compare values and alternatives
6. Assess consequences
7. Decide
Decision Model forEthical Dilemmas
1.Determine the facts
2.Define the ethical issue
3.Identify major values
4.Specify the alternatives
5.Compare values and alternatives
6.Assess the consequences
7.Make the decision