INTERMEDIATE ACCOUNTING I

CHAPTER 2

CONCEPTUAL FRAMEWORK

Need for a conceptual framework

• Coherence in rules and standards.



• Quick solutions to new and emerging practical problems by reference to an existing framework of basic theory.



• Increased user understanding of and confidence in financial reporting.



• Enhanced comparability among companies' financial statements.

First level: Objectives

• Information that is useful to present and potential investors and creditors in making rational investment, credit, and similar decisions.

• Information to help present and potential investors and creditors and other users in assessing the amount, timing, and uncertainty of future cash flows.

• Information about the economic resources of an enterprise, the claims on those resources, and the effects of transactions, events, and circumstances that change its resources and claims to those resources.

Second level: Qualitative characteristics and elements

• Qualitative characteristics - useful for decision making and understandable.

• Primary qualities of useful accounting information.

1. Relevance - capable of making a difference in a decision.
1. Predictive value.
2. Feedback value.
3. Timeliness.



2. Reliability - depend on it to represent the economic conditions or events that it purports to represent.
1. Verifiability.
2. Representational faithfulness.
3. Neutrality.

• Secondary qualities of useful accounting information

1. Comparability - between enterprises
2. Consistency - within an enterprise from period to period

• Elements.

1. Assets - moment in time
2. Liabilities - moment in time
3. Equity - moment in time
4. Investment by owners - period of time
5. Distribution to owners - period of time
6. Comprehensive income - period of time
7. Revenues - period of time.
8. Expenses - period of time.
9. Gains - period of time
10. Losses - period of time

Third level: Recognition and measurement concepts

• Assumptions

1. Economic entity assumption - economic activity can be identified with a particular unit of accountability.
2. Going concern assumption - business enterprises will have a long enough life to justify the use of accruals and deferrals.
3. Monetary unit assumption - the monetary unit (i.e., the dollar) is the most effective means of expressing to interested parties changes in capital and exchanges of goods and services. A second assumption is that the monetary unit remains reasonably stable.
4. Periodicity assumption - activities of an enterprise can be divided into artificial time periods.

• Principles

1. Historical cost principle - definite and objective, not subject to interpretation.



2. Revenue recognition principle - revenue is recognized when the earning process is virtually complete and an exchange transaction has occurred. Exceptions to the revenue recognition principle include:
1. During production - e.g., long-term construction contracts.
2. End of production - e.g., agricultural products, gold.
3. Receipt of cash - e.g., installment sales accounting.



3. Matching principle - efforts (expenses) should be matched with accomplishments (revenues) if feasible.
1. Cash, modified cash, and accrual accounting



2. Matching expenses - analyze costs to determine whether a relationship exists with revenue.



3. When direct association exists, expense costs against revenues in the period when the revenue is recognized.



4. When association exists but is difficult to identify, allocate costs rationally and systematically to expense in the periods benefitted.



5. When little if any association exists, expense immediately.

• Constraints

1. Cost-benefit



2. Materiality



3. Industry practice - peculiar nature of industry or business may result in variation.



4. Conservatism - when in doubt choose the solution that will be least likely to overstate assets and income.

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