1. The Conceptual Framework

What real life concept is the conceptual framework similar to?

It is similar to a constitution

What two things does the conceptual framework enable?

1.  FASB to issue more useful, consistent, and coherent standards and rules over time

2.  The profession to more quickly solve new issues by referring to it.

What does the first level of the conceptual framework have to do with?

Has to do with the why of accounting (the objective).

What is the objective of general purpose financial reporting?

To provide financial information about the reporting entity that is useful to present and potential equity investors, lenders, and other creditors in making decisions about providing resources to the entity.

What is the 2nd level of the conceptual framework?

It contains fundamental concepts that consists of 2 parts qualitative characteristics and elements. It bridges the why of accounting (the objective) with the how of accounting (recognition, measurement, and disclosure concepts).

What are qualitative characteristics in terms of the conceptual framework?

• Qualitative characteristics are meant to enhance decision-usefulness

• States the characteristics that make accounting information useful

• Helps distinguish better (more useful) information from inferior (less useful) information for decision-making purposes.

What are the two categories qualitative characteristics can fall under?

1. Fundamental qualities or

2. Enhancing qualities.

What are the fundamental qualities of the conceptual framework?

1. Relevance

2. Faithful Representation

What falls under Relevance?

1. Predictive value

2. Confirmatory value

3. Materiality

What is predictive value?

info must help users predict future events

What is confirmatory value?

info must help users confirm or change past (or present) expectations

What is a general rule of thumb for materiality?

The general rule of thumb is that anything under 5% of net income is considered immaterial.

However, again, it really depends on the situation. Materiality varies with both relative amounts (quantitative) and relative importance (qualitative).  Thus, good judgment and professional expertise must be applied to determine materiality.

What falls under faithful representation?

1. Completeness

2. Neutrality

3. Free from error

What is faithful representation?

The info is what it really is.

What is completeness?

All the information is there and nothing is missing.

What is neutrality?

Info must be unbiased, cannot have info that shows favoritism.

What is conservatism and does the conceptual framework include it?

The conceptual framework does not include conservatism. Conservatism means that accountants require greater verification before recognizing good news than bad news. As a result losses are reflected in net income more quickly than are gains and net assets tend to be understated instead of overstated.

What are the enhancing qualities of the conceptual framework?

1. Comparability

2. Verifiability

3. Timeliness

4. Understandability

What is comparability?

Info would be better if it were measured and reported in a similar manner. Users could then compare it with similar info from another company.

What is another type of comparability and explain it?

Consistency. This is when companies consistently use the same accounting standards from period to period.

What is verifiability?

independent measurers, using the same methods, can obtain similar conclusions on the info.

What is timeliness?

info must be useful to users before it loses its value in the decision-making process.

What is understandability?

• Info must be presented clearly to users so that they can see its significance.

• Note users of financial reports are assumed to have a reasonable knowledge of business and economic activities.

What is the 3rd level of the conceptual framework?

Has to do with recognition and measurement concepts.

What assumptions are there in the conceptual framework?

1. Economic Entity Assumption

2. Going concern Assumption

3. Monetary Unit Assumption

4. Periodicity Assumption

What is the Economic Entity Assumption?

• The concept that an organization or a section of an organization that, for accounting purposes, stands apart from other organizations, and individuals as a separate entity

• Assumes a company keeps its activity separate from its owners and other business units

What is the monetary unit assumption?

• Assumes that money is the appropriate basis to measure economic activity and performance.

• The U.S. dollar is a very stable unit of measurement and ignores price-level changes (inflation and deflation).

What are the principles of accounting?

1. Measurement principle

2. Revenue recognition principle

3. Expense recognition principle

4. Full disclosure principle

What are the 5 measurement attributes that GAAP has?

1. Historical cost

2. Fair value (aka fair market value or market value)

3. Net realizable value

4. Current cost

5. Present (or discounted) value of future cash flows

What are the two most commonly used measurement attributes?

Historical cost and fair value

What is the Historical cost principle?

GAAP requires that companies must report most assets and liabilities based on the original acquisition price (aka historical cost)

What is the fair value principle?

• Fair value is a market-based measure. Fair value information may be more useful than historical cost for certain types of assets and liabilities and in certain industries.

• GAAP is increasingly calling for the use of fair value measurements in the financial statements

• Historical cost initially equals fair value when something is first purchased. As time passes, the fair value usually changes. Thus, fair value measures or estimates often provide more relevant information about the asset or liability.

What is net realizable value?

It is the estimated selling price in the ordinary cost of business, less reasonably predictable costs of completion, disposal, and transportation.

What is current cost?

It is the cost that would be incurred to purchase or reproduce an asset

What is present value?

Present value bases measurement on future cash flows discounted for the time value of money.

What is the revenue recognition principle?

The revenue recognition principle requires that companies recognize revenue in the accounting period in which the performance obligation is satisfied.

What is the expense recognition principle?

Expenses should be matched with revenues whenever it is reasonable or practicable to do so. Basically, you identify all expenses incurred during a period, measure the expenses, and match them against the revenues earned during that same time period.

What is the full disclosure principle?

Companies must provide information that is of sufficient importance to influence the judgment and decision of an informed user. This doesn’t mean every single detail needs to be presentation, but rather adequate info needs to be presented to allow users to fairly interpret the financial statements and understand how the company is doing.