2 financial reporting: its conceptual framework accounting school · zhongnan university of...

2 Financial Reporting: Its Conceptual Framework

Accounting School · Zhongnan University of Economics & Law

ntermediate Accounntermediate Accountingting

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中级会计学

Intermediate Accounting 2 Financial Reporting: Its Conceptual Framework

1. FASB conceptual framework1. FASB conceptual framework

FASB was given two charges: To develop a conceptual framework of

accounting theory.

To establish standards (GAAP) for financial accounting practices.


Functions of FASB Conceptual FrameworkFunctions of FASB Conceptual FrameworkFunctions of FASB Conceptual FrameworkFunctions of FASB Conceptual Framework

To guide the FASB in establishing accounting standards.

To provide a frame of reference for resolving accounting questions in situations where a standard does not exist.

To determine the bounds for judgment in the preparation of financial statements.

ContinuedContinuedContinuedContinued


Functions of FASB Conceptual FrameworkFunctions of FASB Conceptual FrameworkFunctions of FASB Conceptual FrameworkFunctions of FASB Conceptual Framework

To increase users’ understanding of and confidence in financial reporting.

To enhance comparability.


Statements of Financial Accounting Statements of Financial Accounting Concepts issued by FASBConcepts issued by FASB


Concepts Statement No. 1Objectives of Financial Reporting by Business Enterprises(Issue Date 11/78)

Concepts Statement No. 2Qualitative Characteristics of Accounting Information(Issue Date 5/80)



Concepts Statement No. 3Elements of Financial Statements of Business Enterprises(Issue Date 12/80, replaced by No. 6 in 1985)

Concepts Statement No. 4Objectives of Financial Reporting by Nonbusiness Organizations(Issue Date 12/80)







Concepts Statement No. 5Recognition and Measurement in Financial Statements of Business Enterprises(Issue Date 12/84)

Concepts Statement No. 6Elements of Financial Statements—a replacement of FASB Concepts Statement No. 3 (incorporating an amendment of FASB Concepts Statement No. 2) (Issue Date 12/85)



Concepts Statement No. 7Using Cash Flow Information and Present Value in Accounting Measurements(Issue Date 2/00)




Relationship of Conceptual Framework and Relationship of Conceptual Framework and Standard-Setting ProcessStandard-Setting Process


Conceptual Framework

Objectives and ConceptsObjectives and ConceptsTerms

Identify goals and Identify goals and purpose of accountingpurpose of accounting

Guide the selection of events to Guide the selection of events to be accounted for, the be accounted for, the

measurement of these events, and measurement of these events, and the means of summarizing and the means of summarizing and communicating the information communicating the information

to external users,to external users,

Purpose

Statements of Financial Statements of Financial Accounting ConceptsAccounting Concepts

Documents ContinuedContinuedContinuedContinued




Standard SettingFrom

Objectives and Concepts

Standards

Establish methods and procedures for measuring,

summarizing, and communicating financial accounting information to

external users.Statements of

Financial Accounting Concepts

Statements of Financial Accounting Standards


Conceptual Framework OverviewConceptual Framework Overview

Objectivesof FinancialReporting

QualitativeCharacteristicsof AccountingInformation

Elementsof FinancialStatements

Recognition and Measurement Concepts

Assumptions Principles Constraints


Objectives of Financial Reporting—broad Objectives of Financial Reporting—broad objectivesobjectives

Objectives of Financial Reporting—broad Objectives of Financial Reporting—broad objectivesobjectives

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.

Usefulness


Objectives of Financial ReportingObjectives of Financial ReportingObjectives of Financial ReportingObjectives of Financial Reporting

Financial reporting should provide information that is

understandable to one who has a reasonable knowledge of

accounting and business and who is willing to study and analyze

the information presented.

Understandability


Objectives of Financial ReportingObjectives of Financial ReportingObjectives of Financial ReportingObjectives of Financial Reporting

While there are many potential users of financial reports, the

objectives are directed primarily toward investors and creditors.

Target Audience


Objectives of Financial Reporting—specific Objectives of Financial Reporting—specific objectivesobjectives


Financial reporting should provide information that is useful

in assessing amounts, timing, and uncertainty (risk) of prospective cash flows.

Assessing Future Cash Flows




Financial reporting should also provide information about an

enterprise’s assets, liabilities, and owners’ equity to help investors, creditors, and others evaluate the

financial strengths and weaknesses of the enterprise and its liquidity

and solvency.

Evaluating Economic Resources




Information about enterprise earnings, measured by accrual

accounting, generally provides a better basis for forecasting future

performance than does information about current cash receipts and

disbursements.

Primary Focus on Earnings

Return on investment provides a measure of overall company performance.

Risk is the uncertainty of unpredictability of the future results of a company.

Financial flexibility is the ability of a company to take effective actions to change the amounts and timing of cash flows.

Types of useful informationTypes of useful informationTypes of useful informationTypes of useful information



Liquidity is the term used to describe how quickly an asset can be converted into cash or a liability paid.

Operating capability refers to the ability of a company to maintain a given physical level of operation.

Types of useful informationTypes of useful informationTypes of useful informationTypes of useful information



3. Qualitative characteristics of accounting information

3. Qualitative characteristics of accounting information

FASB Statement of Financial Accounting Concepts No. 2 specifies qualitative

characteristics of accounting information that accounting information should possess in order to be most useful.

Different from China, FASB has set hierarchy of qualitative characteristics.

FASB Statement of Financial Accounting Concepts No. 2 specifies qualitative

characteristics of accounting information that accounting information should possess in order to be most useful.

Different from China, FASB has set hierarchy of qualitative characteristics.

Relevance Reliability

Hierarchy of Qualitative Hierarchy of Qualitative CharacteristicsCharacteristics


Accounting Information

Benefits>CostsBenefits>Costs

Understandability

Decision Usefulness

Pervasive Pervasive ConstraintConstraint

Pervasive Pervasive ConstraintConstraint

User-User-Specific Specific QualityQuality

User-User-Specific Specific QualityQuality

Primary Decision-Specific QualitiesPrimary Decision-Specific QualitiesContinuedContinuedContinuedContinued

Overall Overall QualityQuality

Overall Overall QualityQuality


Ingredients of Primary QualitiesIngredients of Primary Qualities

RelevanceRelevance ReliabilityReliability



Predictive Value

Feedback Value

Timeli-ness

Verifi-ability

Representa-tional

faithfulness

Neu-trality

Secondary and

Interactive Qualities

MaterialityMateriality

Comparability (including Consistency

Threshold for

Recognition


Relevance: making a differenceRelevance: making a difference


Predictive Value Helps a decision maker predict future consequences based

on information about past transactions and events. Feedback Value

Helps to confirm or change a decision maker’s beliefs based on whether the information matches what was expected.

Timeliness Quality of information that is provided on a timely basis.


ReliabilityReliability

Verifiability Reported information should be based on objectively

determined facts that can be verified by other accountants using the same measurement methods.

Representational Faithfulness The amounts and descriptions reported in the financial

statements should reflect the actual results of economic transactions and events.

Neutrality The information should be presented in an unbiased manner;

fairness.

Free from error and represents what it claims to represent.


ComparabilityComparability

Comparability requires that similar events be accounted for in the same manner on the financial statements of (1) different companies and (2) for a particular company for different periods (consistency).


MaterialityMateriality

Is the item large enough to influence the decision of a user of the information?

Is the item large enough to influence the decision of a user of the information?


4. Accounting assumptions and conventions

4. Accounting assumptions and conventions

Certain assumptions and conventions have influenced the development of

generally accepted accounting principles. These are similar with those

of China.

Certain assumptions and conventions have influenced the development of

generally accepted accounting principles. These are similar with those

of China.


EntityEntity

The entity assumption assumes that a proprietorship,

partnership, or corporation’s financial activities are

distinguished from other financial organizations in keeping its own financial

records and reports.

The entity assumption assumes that a proprietorship,

partnership, or corporation’s financial activities are

distinguished from other financial organizations in keeping its own financial

records and reports.


Continuity Continuity

This assumption assumes that the company will continue to

operate in the near future, unless substantial evidence to

the contrary exists. This assumption is also known as the

going-concern assumption.

This assumption assumes that the company will continue to

operate in the near future, unless substantial evidence to

the contrary exists. This assumption is also known as the

going-concern assumption.


Period of TimePeriod of Time

In accordance with the period-of-time assumption, a company prepares financial statements at

the end of each year and includes them its annual report. The period-of-time assumption

is the basis for the adjusting entry process at period-end.

In accordance with the period-of-time assumption, a company prepares financial statements at

the end of each year and includes them its annual report. The period-of-time assumption

is the basis for the adjusting entry process at period-end.


Monetary Unit Monetary Unit

This assumption states that there must be some basis for

measuring exchange of goods or services. Currently the dollar is considered to be a

stable monetary unit for preparing a company’s financial statements.

This assumption states that there must be some basis for

measuring exchange of goods or services. Currently the dollar is considered to be a

stable monetary unit for preparing a company’s financial statements.


Historical CostHistorical Cost

Usually, the exchange price is retained in the accounting

records as the value of an item until it is removed from the

records.

Usually, the exchange price is retained in the accounting

records as the value of an item until it is removed from the

records.


Realization and RecognitionRealization and Recognition

Realization is the process of converting noncash

resources and rights into cash or rights to cash.

Recognition is the process of formally recording and reporting an item in the financial statements of a

company.

Realization is the process of converting noncash

resources and rights into cash or rights to cash.

Recognition is the process of formally recording and reporting an item in the financial statements of a

company.


Matching and Accrual AccountingMatching and Accrual Accounting

The matching principle states that to determine the income of a company for an accounting

period, the company computes the total expense involved in

obtaining the revenues of the period and relates these total

expenses to the total revenues recorded in the period.

The matching principle states that to determine the income of a company for an accounting

period, the company computes the total expense involved in

obtaining the revenues of the period and relates these total

expenses to the total revenues recorded in the period.


ConservatismConservatism

The conservatism convention states that when alternative accounting valuations are

equally possible, the accountant should select the

one that is least likely to overstate assets and income in

the current period.

The conservatism convention states that when alternative accounting valuations are

equally possible, the accountant should select the

one that is least likely to overstate assets and income in

the current period.


5. Elements of financial statements 5. Elements of financial statements

Main financial statements: Balance Sheet Income statement Statement of Cash Flows Statement of Changes in Equity


Elements of a balance sheetElements of a balance sheet

Assets are the probable future economic benefits obtained and controlled by a company as a result of past transactions or events.

Liabilities are the probable future sacrifices of economic benefits arising from present obligations of a company to transfer assets or provide services in the future as a result of past transactions or events.

Equity is the owners’ residual interest in the net assets of a company.


Elements of Income StatementElements of Income Statement

Revenues are inflows or other enhancements of assets of a company or settlement of its liabilities during a period from delivering or producing goods, rendering services, or other activities that are the company’s ongoing major operation. Revenues increase the equity of a company.



Elements of Income Statement Elements of Income Statement

Expenses are outflows or other using up of assets of a company or incurrence of liabilities during a period from delivering or producing goods, rendering services, or carrying out other activities that are the company’s ongoing major operation. Expenses decrease the equity of a company.




Gains are increases in the equity of a company from peripheral or incidental transactions and from all other transactions and other events and circumstances affecting the company, except those that result from revenues or investments by owners. Gains increase the equity of a company.




Losses are decreases in the equity of a company, from peripheral or incidental transactions except those that result from expenses or distribution to owners. Losses decrease the equity of a company.


Elements of Statement of Cash FlowsElements of Statement of Cash Flows

Operating cash flows are the flows of cash from acquiring, selling, and delivering goods for sale, as well as providing services.

Investing cash flows are the flows of cash from acquiring and selling investments, property, plant, and equipment, as well as from lending money and collecting on loans.

Financing cash flows are the flows of cash to and from the owners and long-term creditors.


Elements of Statement of Changes in Equity

Elements of Statement of Changes in Equity

Investments by owners are increases in equity resulting from transfers of something valuable to the company from other entities in order to obtain or increase ownership interest.

Distribution to owners are decreases in equity of a company caused by transferring assets, rendering services, or incurring liabilities to owners.


6. Comparison of accounting concepts in

China and in U.S. 6. Comparison of accounting concepts in

China and in U.S.

Could you compare accounting concepts in China and in U.S.?

Could you compare accounting concepts in China and in U.S.?

The EndThe End