Conceptual Framework of Accounting
The Usefulness of a Conceptual Framework
1. To develop a coherent set of standards and rules
2. To solve new and emerging practical problems
The FASB has issued seven Statements of Financial Accounting Concepts (SFAC) for business enterprises: SFAC No. 1 - Objectives of Financial Reporting
SFAC No. 2 - Qualitative Characteristics of Accounting Information SFAC No. 3 - Elements of Financial Statements (superceded by SFAC No. 6) SFAC No. 4 - Nonbusiness Organizations
SFAC No. 5 - Recognition and Measurement in Financial Statements SFAC No. 6 - Elements of Financial Statements (replaces SFAC No. 3) SFAC No. 7 -Using Cash Flow Information and Present Value in Accounting Measurements
The Framework is comprised of three levels:
First Level = Basic Objectives
Second Level = Qualitative Characteristics and Basic Elements Third Level = Recognition and Measurement Concepts.
First Level: Basic Objectives
Financial reporting should provide information that:
is useful to present and potential investors and creditors and other users in making rational investment, credit, and similar decisions. helps present and potential investors and creditors and other users in assessing the amounts, timing, and uncertainty of prospective cash receipts. portrays the economic resources of an enterprise, the claims to those resources, and the effects of transactions, events, and circumstances that change its resources and claims to those resources.
Second Level: Fundamental Concepts
Question: How does a company choose an acceptable accounting method, the amount and types of information to disclose, and the format in which to present it? Answer: By determining which alternative provides the most useful information for decision-making purposes (decision usefulness).
“The FASB identified the Qualitative Characteristics of accounting information that distinguish better (more useful) information from inferior (less useful) information for decision-making purposes.”
A company may present highly relevant and reliable information, however it was useless to those who do not understand it.
The primary qualities that make accounting information useful for decision making are relevance and reliability. Relevance. Accounting information is relevant if it is capable of making a difference in a decision. For information to be relevant, it should have: Predictive value
Timeliness. It must be presented on a timely basis
Reliability. Accounting information is reliable to the extent that it is verifiable, is a faithful representation and is reasonably free of error and bias. To be reliable, accounting information must include: Verifiable
Neutral - free of error and bias
The secondary qualities identified are comparability and consistency. Comparability. Accounting information that has been measured and reported in a similar manner for different enterprises is considered comparable.. Consistency. Accounting information is consistent when an entity applies the same accounting treatment to similar events from period to period.
Concepts Statement No. 6 defines ten interrelated elements that relate to measuring the performance and financial status of a business enterprise. Assets. Probable future economic benefit obtained or controlled by particular entity as the result of past transactions or events. Liabilities. Probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events. Equity. Residual interest in the assets of an entity that remains after deducting its liabilities. In a business enterprise, the equity is the ownership interest....
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