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Chapter2-1
Conceptual Framework
Underlying Financial Accounting
Chapter2
Intermediate Accounting12th Edition
Kieso, Weygandt, and Warfield
Prepared by Coby Harmon, University of California, Santa Barbara
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Chapter2-2
1. Describe the usefulness of a conceptual framework.2. Describe the FASBs efforts to construct a conceptual
framework.
3. Understand the objectives of financial reporting.
4. Identify the qualitative characteristics of accountinginformation.
5. Define the basic elements of financial statements.
6. Describe the basic assumptions of accounting.
7. Explain the application of the basic principles ofaccounting.
8. Describe the impact that constraints have on reportingaccounting information.
Chapter 2 Learning Objectives
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Chapter2-3
Conceptual
Framework
Need
Development
First Level:
Basic
Objectives
Second Level:
Fundamental
Concepts
Third Level:
Recognition and
Measurement
Basic
assumptions
Basic principles
Constraints
Qualitative
characteristics
Basic elements
Conceptual Framework
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Chapter2-4
The Need for a Conceptual Framework
To develop a coherent set of standards and rules
To solve new and emerging practical problems
Conceptual Framework
LO 1 Describe the usefulness of a conceptual framework.
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Chapter2-5
Review:
A conceptual framework underlying financialaccounting is important because it can lead to
consistent standards and it prescribes thenature, function, and limits of financialaccounting and financial statements.
Conceptual Framework
LO 1 Describe the usefulness of a conceptual framework.
True
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Chapter2-6
Review:
A conceptual framework underlying financialaccounting is necessary because future
accounting practice problems can be solved byreference to the conceptual framework and aformal standard-setting body will not benecessary.
Conceptual Framework
LO 1 Describe the usefulness of a conceptual framework.
False
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Chapter2-7 Objective 2
The FASB has issued six Statements of FinancialAccounting Concepts(SFAC) for business enterprises.
Development of Conceptual Framework
SFAC No.1- Objectives of Financial Reporting
SFAC No.2- Qualitative Characteristics of Accounting InformationSFAC No.3- Elements of Financial Statements (superceded by
SFAC No. 6)
SFAC No.4- Nonbusiness Organizations
SFAC No.5- Recognition and Measurement in Financial StatementsSFAC No.6- Elements of Financial Statements (replaces SFAC No. 3)
SFAC No.7- Using Cash Flow Information and Present Value inAccounting Measurements
LO 2 Describe the FASBs efforts to construct a conceptual framework.
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Chapter2-8
The Framework is comprised of three levels:
First Level= Basic Objectives
Second Level= Qualitative Characteristics andBasic Elements
Third Level= Recognition and MeasurementConcepts.
Conceptual Framework
LO 2 Describe the FASBs efforts to construct a conceptual framework.
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Chapter2-9
ASSUMPTIONS
1. Economic entity
2. Going concern
3. Monetary unit
4. Periodicity
PRINCIPLES
1. Historical cost
2. Revenue recognition
3. Matching
4. Full disclosure
CONSTRAINTS
1. Cost-benefit
2. Materiality
3. Industry practice
4. Conservatism
OBJECTIVES
1. Useful in investment
and credit decisions
2. Useful in assessing
future cash flows
3. About enterprise
resources, claims to
resources, and
changes in them
ELEMENTS
Assets, Liabilities, and Equity
Investments by owners
Distribution to owners
Comprehensive income
Revenues and Expenses
Gains and Losses
Illustration 2-6Conceptual
Framework forFinancialReporting First level
Second level
Third
level
LO 2 Describe the FASBs
efforts to construct aconceptual framework.
QUALITATIVE
CHARACTERISTICS
Relevance
Reliability
Comparability
Consistency
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Chapter2-10
What are the Statements of Financial AccountingConcepts intended to establish?
a. Generally accepted accounting principles in
financial reporting by business enterprises.b. The meaning of Present fairly in accordance with
generally accepted accounting principles.
c. The objectives and concepts for use in developingstandards of financial accounting and reporting.
d. The hierarchy of sources of generally acceptedaccounting principles.
Conceptual Framework
LO 2 Describe the FASBs efforts to construct a conceptual framework.
Review:
(CPA adapted)
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Chapter2-11
Financial reporting should provide information that:(a) is useful to present and potential investors and creditors
and other users in making rational investment, credit, andsimilar decisions.
(b) helps present and potential investors and creditors andother users in assessing the amounts, timing, anduncertainty of prospective cash receipts.
(c) portrays the economic resources of an enterprise, theclaims to those resources, and the effects oftransactions, events, and circumstances that change itsresources and claims to those resources.
First Level: Basic Objectives
LO 3 Understand the objectives of financial reporting.
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Chapter2-12
According to the FASB conceptual framework, theobjectives of financial reporting for businessenterprises are based on?
a. Generally accepted accounting principles
b. Reporting on managements stewardship.
c. The need for conservatism.
d. The needs of the users of the information.
Conceptual Framework
LO 3 Understand the objectives of financial reporting.
(CPA adapted)
Review:
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Chapter2-13
Question:How does a company choose an acceptable accountingmethod, the amount and types of information to
disclose, and the format in which to present it?
Second Level: Fundamental Concepts
LO 4 Identify the qualitative characteristics of accounting information.
Answer:
By determining which alternative provides the most
useful information for decision-making purposes(decision usefulness).
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Chapter2-14
Qualitative Characteristics
The FASB identified the Qualitative Characteristicsof accounting information that distinguish better
(more useful) information from inferior (less useful)information for decision-making purposes.
Second Level: Fundamental Concepts
LO 4 Identify the qualitative characteristics of accounting information.
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Chapter2-15
Second Level: Qualitative Characteristics
LO 4 Identify the qualitative characteristics of accounting information.
Illustration 2-2Hierarchy of
AccountingQualities
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Chapter2-16
Understandability
A company may present highly relevant and reliableinformation, however it was useless to those who do
not understand it.
Second Level: Fundamental Concepts
LO 4 Identify the qualitative characteristics of accounting information.
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Chapter2-17
ASSUMPTIONS
1. Economic entity
2. Going concern
3. Monetary unit
4. Periodicity
PRINCIPLES
1. Historical cost
2. Revenue recognition
3. Matching
4. Full disclosure
CONSTRAINTS
1. Cost-benefit
2. Materiality
3. Industry practice
4. Conservatism
OBJECTIVES
1. Useful in investment
and credit decisions
2. Useful in assessing
future cash flows
3. About enterprise
resources, claims to
resources, and
changes in them
QUALITATIVE
CHARACTERISTICS
Relevance
Reliability
Comparability
Consistency
ELEMENTS
Assets, Liabilities, and Equity
Investments by owners
Distribution to ownersComprehensive income
Revenues and Expenses
Gains and Losses
Illustration 2-6ConceptualFramework forFinancialReporting First level
Second level
Third
levelRelevance and Reliability
LO 4 Identify the qualitative
characteristics ofaccounting information.
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Chapter2-18 LO 4 Identify the qualitative characteristics of accounting information.
Second Level: Qualitative Characteristics
Primary Qualities:Relevancemaking a difference in a decision.
Predictive value
Feedback valueTimeliness
Reliability
Verifiable
Representational faithfulness
Neutral - free of error and bias
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Chapter2-19
Review:
LO 4 Identify the qualitative characteristics of accounting information.
Relevance and reliability are the two primaryqualities that make accounting information usefulfor decision making.
To be reliable, accounting information must be
capable of making a difference in a decision.
True
False
Second Level: Qualitative Characteristics
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Chapter2-20
ASSUMPTIONS
1. Economic entity
2. Going concern
3. Monetary unit
4. Periodicity
PRINCIPLES
1. Historical cost
2. Revenue recognition
3. Matching
4. Full disclosure
CONSTRAINTS
1. Cost-benefit
2. Materiality
3. Industry practice
4. Conservatism
OBJECTIVES
1. Useful in investment
and credit decisions
2. Useful in assessing
future cash flows
3. About enterprise
resources, claims to
resources, and
changes in them
QUALITATIVE
CHARACTERISTICS
Relevance
Reliability
Comparability
Consistency
ELEMENTS
Assets, Liabilities, and Equity
Investments by owners
Distribution to ownersComprehensive income
Revenues and Expenses
Gains and Losses
Illustration 2-6ConceptualFramework forFinancialReporting First level
Second level
Third
level
LO 4 Identify the qualitative
characteristics ofaccounting information.
Comparability and Consistency
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Chapter2-21 LO 4 Identify the qualitative characteristics of accounting information.
Second Level: Qualitative Characteristics
Secondary Qualities:ComparabilityInformation that is measured and
reported in a similar manner for different
companies is considered comparable.Consistency - When a company applies the same
accounting treatment to similar events from periodto period.
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Chapter2-22
Review:
LO 4 Identify the qualitative characteristics of accounting information.
Adherence to the concept of consistencyrequires that the same accounting principles be
applied to similar transactions for a minimum offive years before any change in principle isadopted.
False
Second Level: Qualitative Characteristics
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Chapter2-23
ASSUMPTIONS
1. Economic entity
2. Going concern
3. Monetary unit
4. Periodicity
PRINCIPLES
1. Historical cost
2. Revenue recognition
3. Matching
4. Full disclosure
CONSTRAINTS
1. Cost-benefit
2. Materiality
3. Industry practice
4. Conservatism
OBJECTIVES
1. Useful in investment
and credit decisions
2. Useful in assessing
future cash flows
3. About enterprise
resources, claims to
resources, and
changes in them
QUALITATIVE
CHARACTERISTICS
Relevance
Reliability
Comparability
Consistency
ELEMENTS
Assets, Liabilities, and Equity
Investments by owners
Distribution to ownersComprehensive income
Revenues and Expenses
Gains and Losses
Illustration 2-6ConceptualFramework forFinancialReporting First level
Second level
Third
levelElements
LO 5 Define the basic
elements of financialstatements.
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Chapter2-24
Investment by ownersDistribution to owners
Comprehensive income
Revenue
Expenses
Gains
Losses
Second Level: Elements
Concepts Statement No. 6
defines ten interrelatedelements that relate to measuring the performance andfinancial status of a business enterprise.
AssetsLiabilities
Equity
Moment in Time Period of Time
LO 5 Define the basic elements of financial statements.
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Chapter2-25
Second Level: Elements
Exercise 2-3 Identify the element or elements associatedwith items below.
(a) Arises from peripheral orincidental transactions.
(b) Obligation to transfer
resources arising from apast transaction.
(c) Increases ownershipinterest.
(d) Declares and pays cashdividends to owners.
(e) Increases in net assets in aperiod from nonowner
sources. LO 5 Define the basic elements of financial statements.
(a)
Elements
(b)
(c)
(d)
(c)
(a)
(e)
Assets
Liabilities
EquityInvestment by owners
Distribution to owners
Comprehensive income
RevenueExpenses
Gains
Losses
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Chapter2-26
(g)
Second Level: Elements
Exercise 2-3 Identify the element or elements associatedwith items below.
(f) Items characterized byfuture economic benefit.
(g) Equals increase in netassets during the year,after adding distributionsto owners and subtractinginvestments by owners.
(h) Arises from incomestatement activities thatconstitute the entitysongoing major or central
operations. LO 5 Define the basic elements of financial statements.
(a)
Elements
(b)
(d)
(c)
(a)
(f)
(e)
(h)
(c)
(h)
Assets
Liabilities
EquityInvestment by owners
Distribution to owners
Comprehensive income
RevenueExpenses
Gains
Losses
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Chapter2-27
(g)
Assets
Liabilities
EquityInvestment by owners
Distribution to owners
Comprehensive income
RevenueExpenses
Gains
Losses
Second Level: Elements
Exercise 2-3 Identify the element or elements associatedwith items below.
(i) Residual interest in the netassets of the enterprise.
(j) Increases assets through
sale of product.(k) Decreases assets by
purchasing the companysown stock.
(l) Changes in equity duringthe period, except thosefrom investments byowners and distributions toowners.
LO 5 Define the basic elements of financial statements.
(a)
Elements
(b)
(d)
(c)
(a)
(f)
(e)
(h)
(c)
(h)
(i)
(j)
(k)
(l)
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Chapter2-28
Review:
Second Level: Elements
According to the FASB conceptual framework, anentitys revenue may result from
a. A decrease in an asset from primary operations.b. An increase in an asset from incidentaltransactions.
c. An increase in a liability from incidental
transactions.d. A decrease in a liability from primary operations.
LO 5 Define the basic elements of financial statements.
(CPA adapted)
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Chapter
2-29
Third Level: Recognition and Measurement
The FASB sets forth most of these concepts in itsStatement of Financial Accounting Concepts No. 5,Recognition and Measurement in Financial Statementsof Business Enterprises.
ASSUMPTIONS
1. Economic entity
2. Going concern
3. Monetary unit
4. Periodicity
PRINCIPLES
1. Historical cost
2. Revenue recognition
3. Matching
4. Full disclosure
CONSTRAINTS
1. Cost-benefit
2. Materiality
3. Industry practice
4. Conservatism
LO 6 Describe the basic assumptions of accounting.
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Chapter
2-30
Economic Entitycompany keeps its activityseparate from its owners and other businesses.
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.
Third Level: Assumptions
LO 6 Describe the basic assumptions of accounting.
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Chapter
2-31
Third Level: Assumptions
LO 6 Describe the basic assumptions of accounting.
Brief Exercise 2-4Identify which basic assumption ofaccounting is best described in each item below.
(a) The economic activities of FedEx Corporationare divided into 12-month periods for thepurpose of issuing annual reports.
(b) Solectron Corporation, Inc. does not adjustamounts in its financial statements for theeffects of inflation.
(c) Walgreen Co. reports current and noncurrent
classifications in its balance sheet.(d) The economic activities of General Electric
and its subsidiaries are merged foraccounting and reporting purposes.
Periodicity
Going Concern
MonetaryUnit
EconomicEntity
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Chapter
2-32
Historical Costthe price, established by theexchange transaction, is the cost.
Issues:
Historical cost provides a reliable benchmark formeasuring historical trends.
Fair value information may be more useful.
FASB issued SFAS 15X, Fair Value Measurements(2005).
Reporting of fair value information is increasing.
Third Level: Principles
LO 7 Explain the application of the basic principles of accounting.
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Chapter
2-33
Revenue Recognition - generally occurs (1) whenrealized or realizable and (2) when earned.
Exceptions:
During Production.At End of Production
Upon Receipt of Cash
Third Level: Principles
LO 7 Explain the application of the basic principles of accounting.
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Chapter
2-34
Matching - efforts (expenses) should be matchedwith accomplishment (revenues) whenever it isreasonable and practicable to do so. Let the expensefollow the revenues.
Third Level: Principles
LO 7 Explain the application of the basic principles of accounting.
Illustration 2-4 ExpenseRecognition
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Chapter
2-35
Full Disclosureproviding information that is ofsufficient importance to influence the judgment anddecisions of an informed user.
Provided through:
Financial Statements
Notes to the Financial Statements
Supplementary information
Third Level: Principles
LO 7 Explain the application of the basic principles of accounting.
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Chapter
2-36
Third Level: Principles
LO 7 Explain the application of the basic principles of accounting.
Brief Exercise 2-5Identify which basic principle ofaccounting is best described in each item below.
(a) Norfolk Southern Corporation reports revenuein its income statement when it is earned instead ofwhen the cash is collected.
(b) Yahoo, Inc. recognizes depreciation expense fora machine over the 2-year period during which thatmachine helps the company earn revenue.
(c) Oracle Corporation reports information about
pending lawsuits in the notes to its financialstatements.
(d) Eastman Kodak Company reports land on itsbalance sheet at the amount paid to acquire it, eventhough the estimated fair market value is greater.
RevenueRecognition
Matching
Full
Disclosure
HistoricalCost
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Chapter
2-37
Cost Benefitthe cost of providing the informationmust be weighed against the benefits that can bederived from using it.
Materiality - an item is material if its inclusion or
omission would influence or change the judgment ofa reasonable person.
Industry Practice - the peculiar nature of someindustries and business concerns sometimes requires
departure from basic accounting theory.Conservatismwhen in doubt, choose the solution
that will be least likely to overstate assets andincome.
Third Level: Constraints
LO 8 Describe the impact that constraints haveon reporting accounting information.
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Chapter
2-38
Brief Exercise 2-6 What accounting constraints areillustrated by the items below?
(a) Zips Farms, Inc. reports agricultural cropson its balance sheet at market value.
(b) Crimson Tide Corporation does not accrue acontingent lawsuit gain of $650,000.
(c) Wildcat Company does not disclose anyinformation in the notes to the financialstatements unless the value of the informationto users exceeds the expense of gathering it.
(d) Sun Devil Corporation expenses the cost ofwastebaskets in the year they are acquired.
IndustryPractice
Conservatism
Third Level: Constraints
Cost-Benefit
Materiality
LO 8 Describe the impact that constraints haveon reporting accounting information.
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Chapter
2 39
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