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Conceptual Framework

The document outlines the conceptual framework for financial accounting. It discusses the objectives of financial reporting which are to provide useful information to present and potential investors and creditors for decision making. It also describes the fundamental qualities of accounting information such as relevance, faithful representation, comparability, and understandability. Additionally, it defines key accounting elements like assets, liabilities, equity, revenue, and expenses. The framework also identifies principles for revenue recognition, disclosure, historical cost, and matching as well as constraints like materiality, conservatism, cost-benefit, and industry practices.

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88 views

Conceptual Framework

The document outlines the conceptual framework for financial accounting. It discusses the objectives of financial reporting which are to provide useful information to present and potential investors and creditors for decision making. It also describes the fundamental qualities of accounting information such as relevance, faithful representation, comparability, and understandability. Additionally, it defines key accounting elements like assets, liabilities, equity, revenue, and expenses. The framework also identifies principles for revenue recognition, disclosure, historical cost, and matching as well as constraints like materiality, conservatism, cost-benefit, and industry practices.

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Dat Vu
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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http://quizlet.

com/13891329/chapter-2-conceptual-framework-forfinancial-accounting-flash-cards/
The basic objective of financial reporting
provide 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.
The fundamental qualities of accounting information are:
a. Relevance information that is capable of making a difference
in a decision. Comprised of
1. Predictive value means that the information can help users
form expectations about the future.
2. Confirmatory value means that the information validates or
refutes expectations based on previous evaluations.
3. Materiality means that information is material if omitting it
or misstating it could influence decisions that users make
on the basis of the reported financial information.

b. Faithful representation numbers and descriptions match what


really happened or existed. Comprised of
1. Completeness
provided.

meaning

all

necessary

information

is

2. Neutrality meaning the information is unbiased.


3. Free from error meaning the information is accurate.
Enhancing qualities
include:

complement

the

fundamental

qualities

and

a. Comparability companies record and report information in a


similar manner. Consistency is another type of comparability
and means the company uses the same accounting methods
from period to period.
b. Verifiability independent people using the same methods
arrive at similar conclusions.
c. Timeliness information is available before it loses its
relevance.
d.
Understandability reasonably informed users should be
able to comprehend the information that is clearly classified and
presented.
The elements include:

Assets: A resource that has probable future economic value


Liabilities: Obligations of the business to pay money or provide service
Equity: The owners' claims on the assets
Revenue: Resources earned when the business provides goods /
services
Expense: The costs of earning revenue; services received or used up
assets other than cash
Gains: Increases in equity from incidental transactions
Losses: Decreases in equity from incidental transactions
Comprehensive income: All changes in equity other than investments
by and distributions to owners
Investments increases in equity from owners
Distributions decreases in equity due to various types of payments to
owners (dividends, drawings, treasury stock)
Accountants make certain assumptions in financial reporting:

Monetary unit: Transactions are measured in dollars; the value of


a dollar is constant (i.e., we do not account for inflation in the
US). We assume that the monetary unit is stable, so we dont
take into account the effects of inflation. We can add together
assets purchased in 1990 and 2010.
Economic entity: The business is economically separated from
its owners. This helps investors/creditors differentiate between
competing companies.
Periodicity: For financial reporting, the life of a business is
broken down into discrete periods (such as a quarter or a year).
Going concern: A business will survive long enough to meet its
current commitments. Which is why we have the historical cost
principle (not liquidation values), we have
depreciation/amortization expenses, the concept of current and
non-current assets.
In addition, four broad principles are identified in the framework:
Revenue recognition: Revenue is recognized (recorded in the
books) when it is earned (work is done or product is delivered)
and realized (assets are received and are readily convertible into
cash). Revenue is usually recognized at the point of sale, but can
be recognized during production (construction contracts), end of
production (ready market with set prices like gold, oil, corn etc);
when cash is received (instalment sales)
Full disclosure: Financial reporting should disclose all necessary
information for making decisions in the main financial
statements, in the footnotes or in the supplemental schedules.
Historical cost: In most cases, assets are recorded at their
historical cost (i.e., what was paid for them).
Fair value: Price to sell an asset or settle a liability at the
measurement date. Three levels: Level 1 has an observable
market with quoted prices; Level 2 has observable external data;
Level 3 companys own data or assumptions
Matching: The costs of earning revenue should be presented on
the same income statement as the revenue they generated.
More simply stated, it costs money to make money. We can have
product costs that can be directly matched to revenue (for
example, material, labor, overhead, cost of goods sold) and
period costs that are expensed in the period they are incurred
(example, advertising, administrative salaries)
And, finally, the framework lists four constraints that must be
considered in financial reporting:
Materiality: If an amount is too small to impact a decision, strict

accounting principles can be ignored. It can be material in


quantity or quality. Auditors use 5% of net income as rule of
thumb.
Conservatism: When faced with choices about financial
reporting, make the choice that is least likely to overstate assets
and income. Examples will be using lower of cost or market for
inventory, and recognizing possible future losses only rather than
possible future gains.
Cost / benefit: The cost of obtaining information should always
be less than the benefit of having it.
Industry practices: The nature of some industries sometimes
requires a departure from general rules of financial reporting.
Public utility companies report non-current assets first, and
agricultural companies report crops at fair value.

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