Conceptual Framework of Financial Reporting
The framework does not constitute GAAP but rather provides consistent direction for the development of specific GAAP. The conceptual framework is a "constitution" for developing specific GAAP.
Conceptual Framework Outline
1. Objective of financial reporting;
2. Qualitative characteristics of accounting information;
3. Accounting assumptions;
4. Basic accounting principles;
5. Accounting constraints;
6. Elements of financial statements.
What is Comparability?
The quality of information that enables users to identify similarities and differences between sets of information.
What is completeness?
Information is complete if it includes all data necessary to be faithfully representative.
What are the ingredients of Faithful representation?
Completeness, Free from material error, Neutrality.
What is Understandability?
Information is understandable if the user comprehends it with reasonable effort and diligence.
Who is the Target Audience of Financial Statements?
Decision makers; mainly potential investors, creditors, and regulators.
What are the Primary Qualitative Characteristics of Financial Information?
Relevance, Faithful representation.
What is Timeliness?
To be relevant, accounting information must be received in time to make a difference to the decision maker.
What is Verifiability?
Information is verifiable if different knowledgeable and independent observers can reach similar conclusions.
What are the Ingredients of Relevance?
Predictive value, Confirmatory value.
What is Confirmatory Value?
To be relevant, accounting information should assist decision makers in confirming past predictions.
What is Predictive Value?
To be relevant, accounting information should assist financial statement users in making predictions about future events.
What are Objectives of Financial Reporting?
To provide information about the entity to current and future users of the financial statements who are making credit and investment decisions.
What is Neutrality?
To be neutral, accounting information must be free of bias.
What does it mean to be free from material error?
Information is free from material error if it is accurate and truthful.
List the enhancing qualitative characteristics of financial information.
Comparability;
Verifiability;
Timeliness;
Understandability.
What does the matching principle state?
Recognize expenses only when expenditures help to produce revenues.
What is the entity assumption?
We assume there is a separate accounting entity for each business organization.
How do we measure a revenue?
Revenues are measured as the cash equivalent amount of the good or service provided.
What does the historical cost accounting principle state?
Assets and liabilities are recorded at historical cost, that is, their cash equivalent amount at time of origination. This value is the market value of the item on the date of acquisition.
When does realization occur in the accounting period?
(1) Goods or services have been provided, (2) Collectability of cash is assured, (3) Expenses of providing goods and services can be determined.
What is the concept of capital maintenance?
Capital is said to be maintained when the firm has positive earnings for the year, assuming no changes in price levels.
What is the time period assumption?
The indefinite life of a business is broken into smaller time frames, typically a year, for evaluation purposes and reporting purposes.
What does the full disclosure principle state?
Financial statements should present all information needed by an informed reader to make an economic decision. This principle is sometimes referred to as the adequate disclosure principle.
What is the going concern assumption?
In the absence of information to the contrary, a business is assumed to have an indefinite life, that is, it will continue to be a going concern.
What are revenues?
Revenues are increases in assets or extinguishment of liabilities stemming from delivery of goods or from providing services -- the main activities of the firm.
When should a company recognize revenues?
Revenues are recognized when they are earned and collectability is reasonably assured.
What is the unit of measurement assumption?
Assets, liabilities, equities, revenues, expenses, gains, losses, and cash flows are measured in terms of the monetary unit of the country in which the business is operated.
What is Cost Effectiveness?
This constraint on Generally Accepted Accounting Principles (GAAP) limits recognition and disclosure if the cost of providing the information exceeds its benefit.
What does a fresh start measurement do?
Establishes a new carrying value after an initial recognition and is unrelated to previous amounts (e.g., mark-to-market accounting and recognition of asset impairments).
What are the two accounting constraints?
Materiality and cost effectiveness (or cost-benefit).
List the elements which a present value measurement that fully captures economic differences should include.
(1) An estimate of future cash flows, (2) Expectations about variations in amount or timing of those cash flows, (3) Time value of money as measured by the risk-free rate of interest, (4) The price for bearing the uncertainty inherent in the asset or liab
To what conditions do accounting constraints refer?
These constraints refer to a condition for which the normal measurement and recognition rules are modified.
What are the four criteria that must be met to be recognized and measured in a financial report?
Definition,
Measurability,
Relevance,
Reliability.
Define cost effectiveness.
This constraint on Generally Accepted Accounting Principles (GAAP) limits recognition and disclosure if the cost of providing the information exceeds its benefit.
What is Conservatism?
Conservatism (also called prudence) is the reporting of less optimistic amounts (lower income, net assets) under conditions of uncertainty or when Generally Accepted Accounting Principles (GAAP) provides a choice from among recognition or measurement meth
List the elements included in a full set of financial statements.
(1) Balance sheet, (2) Income statement, (3) Statement of comprehensive income, (4) Statement of cash flows, (5) Statement of owner's equity.