CHAPTER 2

CONCEPTUAL FRAMEWORK FOR

FINANCIAL REPORTING

Chapter
2-1
 Learning
Learning Objectives
Objectives

1. Describe the usefulness of a conceptual framework.

2. Describe efforts to construct a conceptual framework.

3. Understand the objective of financial reporting.

4. Identify the qualitative characteristics of accounting information.

5. Define the basic elements of financial statements.

6. Describe the basic assumptions of accounting.

7. Explain the application of the basic principles of accounting.

8. Describe the impact that constraints have on reporting

accounting information.

Chapter
2-2
 Conceptual
Conceptual Framework
Framework For
For Financial
Financial Reporting
Reporting

Third Level:
Second Level: Recognition,
Conceptual First Level: Basic
Fundamental Measurement, and
Framework Objective
Concepts Disclosure
Concepts

Need Qualitative Basic assumptions

characteristics
Development Basic principles
Basic elements
Overview Constraints
Summary of the
structure

Chapter
2-3
 Conceptual
Conceptual Framework
Framework

Conceptual Framework establishes the concepts

that underlie financial reporting.

Need for a Conceptual Framework

Rule-making should build on and relate to an

established body of concepts.

Enables IASB to issue more useful and consistent

pronouncements over time.

Chapter
2-4 LO 1 Describe the usefulness of a conceptual framework.
 Conceptual
Conceptual Framework
Framework

Development of a Conceptual Framework

IASB and FASB are working on a joint project to
develop a common conceptual framework

Framework will build on existing IASB and FASB

frameworks.

Project has identified the objective of financial

reporting (Chapter 1) and the qualitative
characteristics of decision-useful financial reporting
information.
Chapter
2-5 LO 2 Describe efforts to construct a conceptual framework.
 Conceptual
Conceptual Framework
Framework

Overview of the Conceptual Framework

Three levels:
First Level = Basic objective

Second Level = Qualitative characteristics and

elements of financial statements

Third Level = Recognition, measurement, and

disclosure concepts

Chapter
2-6 LO 2 Describe efforts to construct a conceptual framework.
 ASSUMPTIONS PRINCIPLES CONSTRAINTS
1. Economic entity 1. Measurement 1. Cost
2. Going concern 2. Revenue recognition 2. Materiality
Third
3. Monetary unit 3. Expense recognition
level
4. Periodicity 4. Full disclosure
5. Accrual

QUALITATIVE
CHARACTERISTICS ELEMENTS
1. Fundamental 1. Assets
qualities 2. Liabilities Second level
2. Enhancing 3. Equity
qualities 4. Income
5. Expenses
Illustration 2-7
Framework for Financial
Reporting OBJECTIVE
Provide information
about the reporting
entity that is useful
to present and potential First level
equity investors,
lenders, and other
creditors in their
capacity as capital
Chapter Providers. LO 2 Describe efforts to construct
2-7 a conceptual framework.
 First
First Level:
Level: Basic
Basic Objective
Objective

OBJECTIVE
“To provide financial information about the reporting entity
that is useful to present and potential equity investors,
lenders, and other creditors in making decisions in their
capacity as capital providers.”

 Provided by issuing general-purpose financial statements.

 Assumption is that users have reasonable knowledge of business
and financial accounting matters to understand the information.

Chapter
2-8 LO 3 Understand the objectives of financial reporting.
 Second
Second Level:
Level: Fundamental
Fundamental Concepts
Concepts

Qualitative Characteristics of Accounting

Information

IASB identified the Qualitative Characteristics of

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

Chapter
2-9 LO 4 Identify the qualitative characteristics of accounting information.
 Second
Second Level:
Level: Fundamental
Fundamental Concepts
Concepts

Illustration 2-2
Hierarchy of Accounting
Qualities

Chapter
2-10 LO 4 Identify the qualitative characteristics of accounting information.
 Second
Second Level:
Level: Fundamental
Fundamental Concepts
Concepts

Fundamental Quality - Relevance

Relevance is one of the two fundamental qualities that make
accounting information useful for decision-making.

Chapter
2-11 LO 4 Identify the qualitative characteristics of accounting information.
 Second
Second Level:
Level: Fundamental
Fundamental Concepts
Concepts

Fundamental Quality – Faithful Representation

Faithful representation means that the numbers and
descriptions match what really existed or happened.

Chapter
2-12 LO 4 Identify the qualitative characteristics of accounting information.
 Second
Second Level:
Level: Fundamental
Fundamental Concepts
Concepts

Enhancing Qualities
Distinguish more-useful information from less-useful
information.

Chapter
2-13 LO 4 Identify the qualitative characteristics of accounting information.
 ASSUMPTIONS PRINCIPLES CONSTRAINTS
1. Economic entity 1. Measurement 1. Cost
2. Going concern 2. Revenue recognition 2. Materiality
Third
3.

4.
Monetary unit
Periodicity
Basic
Basic
3.
Elements
Expense recognition
Elements
Full disclosure
4.
level

5. Accrual

QUALITATIVE
CHARACTERISTICS ELEMENTS
1. Fundamental 1. Assets
qualities 2. Liabilities Second level
2. Enhancing 3. Equity
qualities 4. Income
5. Expenses
Illustration 2-7
Framework for Financial
Reporting OBJECTIVE
Provide information
about the reporting
entity that is useful
to present and potential First level
equity investors,
lenders, and other
creditors in their
capacity as capital
Chapter Providers.
2-14 LO 4
 Second
Second Level:
Level: Basic
Basic Elements
Elements

Chapter
2-15 LO 5 Define the basic elements of financial statements.
 Second
Second Level:
Level: Basic
Basic Elements
Elements
Exercise 2-4: Identify the qualitative characteristic(s) to be used
given the information provided. Characteristics
(a) Qualitative characteristic being Relevance
employed when companies in the Faithful representation
same industry are using the same
Predictive value
accounting principles.
Confirmatory value
(b) Quality of information that confirms Neutrality
users’ earlier expectations.
Completeness
(c) Imperative for providing comparisons Timeliness
of a company from period to period.
Verifiability
(d) Ignores the economic consequences Understandability
of a standard or rule. Comparability
Chapter
2-16 LO 5
 Second
Second Level:
Level: Basic
Basic Elements
Elements
Exercise 2-4: Identify the qualitative characteristic(s) to be used
given the information provided. Characteristics
(e) Requires a high degree of consensus Relevance
among individuals on a given Faithful representation
measurement.
Predictive value
(f) Predictive value is an ingredient of this Confirmatory value
fundamental quality of information. Neutrality
(g) Qualitative characteristics that Completeness
enhance both relevance and faithful Timeliness
representation.
Verifiability
Understandability
Comparability
Chapter
2-17 LO 5
 Second
Second Level:
Level: Basic
Basic Elements
Elements
Exercise 2-4: Identify the qualitative characteristic(s) to be used
given the information provided. Characteristics
(h) Neutrality and completeness are Relevance
ingredients of this fundamental quality Faithful representation
of accounting information.
Predictive value
(i) Two fundamental qualities that make Confirmatory value
accounting information useful for Neutrality
decision-making purposes.
Completeness
(j) Issuance of interim reports is an Timeliness
example of what enhancing
Verifiability
ingredient?
Understandability
Comparability
Chapter
2-18 LO 5
 Third
Third Level:
Level: Recognition,
Recognition, Measurement,
Measurement, and
and
Disclosure
Disclosure Concepts
Concepts

These concepts explain how companies should recognize,

measure, and report financial elements and events.

Recognition, Measurement, and Disclosure Concepts

ASSUMPTIONS PRINCIPLES CONSTRAINTS
1. Economic entity 1. Measurement 1. Cost
2. Going concern 2. Revenue recognition 2. Materiality
3. Monetary unit 3. Expense recognition
4. Periodicity 4. Full disclosure
5. Accrual

Illustration 2-7
Framework for
Financial Reporting

Chapter
2-19 LO 6 Describe the basic assumptions of accounting.
 Third
Third Level:
Level: Assumptions
Assumptions

Basic Assumptions
Economic Entity – company keeps its activity separate from
its owners and other business unit.
Going Concern - company to last long enough to fulfill
objectives and commitments.
Monetary Unit - money is the common denominator.
Periodicity - company can divide its economic activities into
time periods.
Accrual Basis of Accounting – transactions are recorded in
the periods in which the events occur.
Chapter
2-20 LO 6 Describe the basic assumptions of accounting.
 Third
Third Level:
Level: Assumptions
Assumptions
E2-8: Identify which basic assumption of accounting is best
described in each item below.
(a) The economic activities of FedEx Corporation
(USA) are divided into 12-month periods for the Periodicity
purpose of issuing annual reports.
(b) Total S.A. (FRA) does not adjust amounts in its Monetary
financial statements for the effects of inflation. Unit
(c) Barclays (GBR) reports current and non-current
classifications in its statement of financial Going Concern
position.
(d) The economic activities of Tokai Rubber
Industries (JPN) and its subsidiaries are merged Economic
for accounting and reporting purposes. Entity
Chapter
2-21 LO 6 Describe the basic assumptions of accounting.
 Third
Third Level:
Level: Principles
Principles
Principles
Measurement
Cost is generally thought to be a faithful representation of the
amount paid for a given item.
Fair value is “the amount for which an asset could be exchanged,
a liability settled, or an equity instrument granted could be
exchanged, between knowledgeable, willing parties in an arm’s
length transaction.”

IASB has taken the step of giving companies the option to use fair
value as the basis for measurement of financial assets and
financial liabilities.

Chapter
2-22 LO 7 Explain the application of the basic principles of accounting.
 Third
Third Level:
Level: Principles
Principles

Revenue Recognition - revenue is to be recognized when it

is probable that future economic benefits will flow to the company
and reliable measurement of the amount of revenue is possible.
Illustration 2-3
Timing of Revenue Recognition

Chapter
2-23 LO 7 Explain the application of the basic principles of accounting.
 Third
Third Level:
Level: Principles
Principles

Expense Recognition - outflows or “using up” of assets

or incurring of liabilities (or a combination of both) during a
period as a result of delivering or producing goods and/or
rendering services. Illustration 2-4
Expense Recognition

“Let the expense follow the revenues.”

Chapter
2-24 LO 7 Explain the application of the basic principles of accounting.
 Third
Third Level:
Level: Principles
Principles

Full Disclosure – providing information that is of sufficient

importance to influence the judgment and decisions of an
informed user.

Provided through:
Financial Statements
Notes to the Financial Statements
Supplementary information

Chapter
2-25 LO 7 Explain the application of the basic principles of accounting.
 Third
Third Level:
Level: Principles
Principles
BE2-9: Identify which basic principle of accounting is best
described in each item below.
Revenue
(a) Parmalat (ITA) reports revenue in its income
statement when it is earned instead of when the
Recognitio
cash is collected. n

(b) Google (USA) recognizes depreciation expense for Expense

a machine over the 2-year period during which that Recognitio
machine helps the company earn revenue. n
(c) KC Corp. (USA) reports information about pending Full
lawsuits in the notes to its financial statements. Disclosure
(d) Fuji Film (JPN) reports land on its balance sheet at
the amount paid to acquire it, even though the
estimated fair market value is greater. Measurement
Chapter
2-26 LO 7 Explain the application of the basic principles of accounting.
 Third
Third Level:
Level: Constraints
Constraints

Constraints
Cost – the cost of providing the information must be weighed
against the benefits that can be derived from using it.

Materiality - an item is material if its inclusion or omission

would influence or change the judgment of a reasonable
person.

Chapter LO 8 Describe the impact that constraints have on

2-27 reporting accounting information.
 Third
Third Level:
Level: Constraints
Constraints
E2-11: What accounting constraints are illustrated by the
items below?

(a) Willis Company does not disclose any

information in the notes to the financial Cost
statements unless the value of the information
to users exceeds the expense of gathering it.

(b) Beckham Corporation expenses the cost of

Materiality
wastebaskets in the year they are acquired.

Chapter LO 8 Describe the impact that constraints have on

2-28 reporting accounting information.
 Summary of
the Structure

Chapter
2-29
  The existing conceptual frameworks underlying U.S. GAAP and IFRS
are very similar.
 The converged framework should be a single document, unlike the two
conceptual frameworks that presently exist.
 Both the IASB and FASB have similar measurement principles, based
on historical cost and fair value. However, U.S. GAAP has a concept
statement to guide estimation of fair values when market-related data is
not available (Statement of Financial Accounting Concepts No. 7,
“Using Cash Flow Information and Present Value in Accounting”). The
IASB is considering a proposal to provide expanded guidance on
Chapter
estimating fair values.
2-30
 Copyright
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Chapter
2-31