Intermediate Accounting, 10th Edition

Kieso, Weygandt, and Warfield

Chapter 2: The Conceptual

Framework
Prepared by
Drs.Gusnardi.SE.,Ak
Pekanbaru
 Introduction
• Users of financial statements need relevant and
reliable information.
• To provide such information, the profession
has developed a set of principles and guidelines.
• These principles and guidelines are
collectively called the Conceptual Framework.
• In short, the Framework is like a constitution
for the profession.

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 Objectives of the Conceptual
Framework
• The Framework is to be the foundation for
building a set of coherent accounting
standards and rules.
• The Framework is to be a reference of basic
accounting theory for solving emerging
practical problems of reporting.

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 Statements of Financial Accounting
Concepts
• The FASB has issued seven Statements of
Financial Accounting Concepts (SFACs) to
date (Statements 1 through 7.)
• These statements set forth major recognition
and reporting issues.
• Statement 4 pertains to reporting by
nonbusiness entities.
• The other six statements pertain to reporting
by business enterprises.
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 Statements of Financial Accounting
Concepts
Statement Brief Title
• Statement 1 • Objectives of Financial
Reporting (Business)
• Statement 2 • Qualitative Characteristics
• Statement 6 • Elements of Financial
Statements (replaces 3)
• Statement 4 • Objectives of Financial
Reporting (Nonbusiness)
• Statement 5 • Recognition and
Measurement Criteria
• Statement 7 • Using Cash Flows
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 Overview of the Conceptual
Framework (1 of 2)
• The Framework has three levels of
objectives, elements and criteria.
• The first level consists of objectives.
• The second level explains financial
elements and characteristics of information
• The third level incorporates recognition and
measurement criteria.

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Overview of the Conceptual Framework (2
of 2)
Level 3: Recognition and
Implemen- Measurement Concepts
tation

Level 2: Elements of
Qual Financial Statements and
Elements
Charac. Qualitative Characteristics
of Accounting Information

Objectives Level 1: Objectives of

Financial Reporting
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 Basic Objectives of Financial
Reporting
•• To
To provide
provide information
information::
•• about economic resources
abouteconomic resources,,the
theclaims
claimson
onthose
those
resourcesand
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them
•• thatisisuuseful
that tothose
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investmentand
andcredit
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decisions
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presentand
andfuture
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in
assessing future
assessing future cash
cash flows
flows
•• to
toindividuals
individualswho
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understandbusiness
businessand
and
economicactivities.
economic activities.

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 Qualitative Characteristics of
Accounting Information
• Primary qualities are Relevance and
Reliability of accounting information.
• Secondary qualities are comparability and
consistency of reported information.

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 Qualitative Characteristics of
Accounting Information: Relevance
• Relevance of information means “information
capable of making a difference in a decision
context.”
• The information must be timely to be relevant.
• The information should have predictive value: (be
helpful in making predictions about ultimate
outcomes of past, present and future events).
• The information should have feedback value
(helps users to confirm prior expectations.)

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 Primary Characteristic: Reliability
• Information is reliable, when it can be relied on to
represent the true, underlying situation.
• To be reliable, information must be:
1 * verifiable
2 * representationally faithful, and
3 * neutral

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 Primary Characteristic: Reliability

• Information is verifiable, when, given the

same information, independent users can
arrive at the same conclusion.
• Information is faithful, when it represents
what really existed or happened.
• Information is neutral, when it is free from
bias.

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 Secondary Characteristics
• Secondary characteristics are: comparability and
consistency of reported information.
• For information to be comparable, it must be:
1 measured and reported in a similar manner for different
enterprises.
2 useful in the allocation of resources to the areas of
greatest benefit.
3 useful to users in identifying real differences between
enterprises.

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 Secondary Characteristics
• Accounting information is consistent, if the same
accounting principles are applied in a similar
manner from one period to the next.
• Accounting principles may be changed, if the
change results in better reporting.
• If principles are changed, the justification for, and
the nature and effect of the change, must be
disclosed.

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 Hierarchy of Accounting Qualities
Decision Makers What are their characteristics?

Constraints Cost benefit & Materiality

User specific Qualities Understandability

Pervasive Criterion Decision Usefulness

Primary Qualities Relevance & Reliability

Secondary Qualities Comparability & Consistency

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 Ingredients of Primary Qualities
Relevance Reliability

Predictive Feedback Represent.

Verifiability Neutrality
Faithfulness
Value Value

Timeliness

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 Basic Elements of Financial Statements
Balance Sheet
• Assets: Probable future
economic benefits
• Liabilities: Probable future
sacrifices of economic benefits
• Equity: Residual or ownership
interest
• Investment by Owners:
Increases in net assets
• Distributions to Owners:
Decreases in net assets
Income Statement
• Comprehensive Income:
Changes in equity from non-
owner sources
• Revenues: Inflows from
entity’s ongoing operations
• Expenses: Outflows from
entity’s ongoing operations
• Gains: Increases in equity from
incidental transactions
• Losses: Decreases in equity
from incidental transactions

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 Recognition and Measurement
Criteria
Basic
Principles Constraints
Assumptions

1. Economic 1. Historical cost 1. Cost Benefit

entity 2. Revenue 2. Materiality
2. Going recognition 3. Industry
concern 3. Matching practices
3. Monetary 4. Full Disclosure 4. Conservatism
Unit
4. Periodicity

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 Basic Assumptions

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 Basic Assumptions
• Economic Entity Assumption
1 The economic entity can be identified with a particular
unit of accountability.
2 The business is separate and distinct from its owners
3 Entity’s assets and other financial elements are not
commingled with those of the owners.
4 The economic entity assumption is an accounting
concept, and not a legal construct.
5 Departments or divisions of an entity may be
considered separate entities.
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 Basic Assumptions
• Going Concern Assumption
– The business is assumed to continue
indefinitely unless terminated by owners.
– The basis of recording financial elements is
historical accounting.
– Liquidation accounting (based on liquidation
values) is not followed unless so indicated.

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 Basic Assumptions
• Monetary Unit
– Money is the common unit of measure of
economic transactions.
– Use of a monetary unit is relevant, and simple
to understand.
– The dollar is assumed to remain relatively
stable in value.

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 Basic Assumptions
• Periodicity (Time Period) Assumption
– Economic activity of an entity may be
artificially divided into time periods for
reporting purposes.
– Shorter time periods are subject to revisions but
may be more timely.

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 Basic Principles

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 The Cost Principle
• Historical Cost Principle
– Transaction is recorded at its acquisition price.
– It is not changed to reflect market price.
– The principle applies to assets and liabilities.
– Users of financial statements may find current fair
value information to be useful as well.
– A “mixed attribute” system reports historical cost, fair
value, and lower of cost or market values.

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 The Revenue Recognition Principle
• Revenue Recognition Principle
– Revenue is recognized when it is earned and the
amount can be objectively determined.
– Revenue is recognized at time of sale. There are
exceptions:
1 In long-term construction (completed) contracts (revenue is
recognized only on completion of contract).
2 Where active markets exist for the product (revenue is
recognized end of production and before sale)
3 In installment sales contracts (revenue is recognized only on
receipt of cash)

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 The Matching Principle
• Expenses in one period are matched to revenues of
the same period.
• There should be a logical, rational association of
revenues and expenses.
• If an expense does not benefit future periods, it is
recorded in the current period.
• Both product and period costs must be
appropriately matched.

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 The Full Disclosure Principle
• Financial statements must report what a
reasonable person would need to know to make
an informed decision.
• Disclosure may be made:
1 within the body of the financial statements,
2 as notes to those statements, or
3 as supplementary information.

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 Constraints

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 Constraints: The Cost Benefit Rule
• Cost-Benefit Relationship
– The cost of providing information should not outweigh
the benefit derived.
– Costs and benefits are not always obvious or
quantifiable.
– Sound judgment must be used in providing information.

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 Constraints: Materiality
• Materiality refers to an item’s importance to a
firm’s overall financial operations.
– An item must make a difference to be material and be
disclosed.
– It is a matter of the relative significance of the element.
– Both quantitative and qualitative factors are to be
considered in determining relative significance.

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 Constraints: Industry Practices
• Industry Practices
– The nature of some industries may sometimes
require departures from basic accounting
theory.
– If application of accounting theory results in
statements that are not comparable or
consistent, then industry practices must
examined for possible explanations.

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 Constraints: Conservatism
• Conservatism suggests that the preparer, when in
doubt, choose a conservative solution.
• This solution will be least likely to overstate assets
and income.
• Conservatism does not suggest that net assets or
net income be deliberately understated.

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 COPYRIGHT
Copyright © 2001 John Wiley & Sons, Inc. All rights
reserved. Reproduction or translation of this work
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these programs or from the use of the information
contained herein.

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