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Chapter 2 Learning Objectives Describe the usefulness of a conceptual framework. Describe the FASB’s efforts to construct a conceptual framework. Understand the objectives of financial reporting. Identify the qualitative characteristics of accounting information. Define the basic elements of financial statements. Describe the basic assumptions of accounting. Explain the application of the basic principles of accounting. Describe the impact that constraints have on reporting accounting information.

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Chapter 2-1 Conceptual Framework Conceptual Framework Underlying Financial Accounting Underlying Financial Accounting Chapter Chapter 2 2 Intermediate Accounting 12th Edition Kieso, Weygandt, and Warfield Prepared by Coby Harmon, University of California, Santa Barbara
Chapter 2-2 1. 1. Describe the usefulness of a conceptual framework. Describe the usefulness of a conceptual framework. 2. 2. Describe the FASB’s efforts to construct a conceptual Describe the FASB’s efforts to construct a conceptual framework. framework. 3. 3. Understand the objectives of financial reporting. Understand the objectives of financial reporting. 4. 4. Identify the qualitative characteristics of accounting Identify the qualitative characteristics of accounting information. information. 5. 5. Define the basic elements of financial statements. Define the basic elements of financial statements. 6. 6. Describe the basic assumptions of accounting. Describe the basic assumptions of accounting. 7. 7. Explain the application of the basic principles of Explain the application of the basic principles of accounting. accounting. 8. 8. Describe the impact that constraints have on reporting Describe the impact that constraints have on reporting accounting information. accounting information. Chapter 2 Learning Objectives Chapter 2 Learning Objectives
Chapter 2-3 Conceptual Conceptual Framework Framework Need Need Development Development First Level: First Level: Basic Basic Objectives Objectives Second Level: Second Level: Fundamental Fundamental Concepts Concepts Third Level: Third Level: Recognition and Recognition and Measurement Measurement Basic Basic assumptions assumptions Basic principles Basic principles Constraints Constraints Qualitative Qualitative characteristics characteristics Basic elements Basic elements Conceptual Framework Conceptual Framework
Chapter 2-4 The Need for a Conceptual Framework To develop a coherent set of standards and rules To solve new and emerging practical problems Conceptual Framework Conceptual Framework LO 1 Describe the usefulness of a conceptual framework. LO 1 Describe the usefulness of a conceptual framework.
Chapter 2-5 Review: Review: conceptual framework underlying financial conceptual framework underlying financial accounting is important because it can lead to accounting is important because it can lead to consistent standards and it prescribes the consistent standards and it prescribes the nature, function, and limits of financial nature, function, and limits of financial accounting and financial statements. accounting and financial statements. Conceptual Framework Conceptual Framework LO 1 Describe the usefulness of a conceptual framework. LO 1 Describe the usefulness of a conceptual framework. True True
Chapter 2-6 Review: Review: A conceptual framework underlying financial A conceptual framework underlying financial accounting is necessary because future accounting is necessary because future accounting practice problems can be solved by accounting practice problems can be solved by reference to the conceptual framework and a reference to the conceptual framework and a formal standard-setting body will not be formal standard-setting body will not be necessary. necessary. Conceptual Framework Conceptual Framework LO 1 Describe the usefulness of a conceptual framework. LO 1 Describe the usefulness of a conceptual framework. False False
Chapter 2-7 Objective 2 Objective 2 The FASB has issued six Statements of Financial Accounting Concepts (SFAC) for business enterprises. Development of Conceptual Framework Development of Conceptual Framework SFAC No.1 - Objectives of Financial Reporting SFAC No.2 - Qualitative Characteristics of Accounting Information SFAC No.3 - Elements of Financial Statements (superceded by SFAC No. 6) SFAC No.4 - Nonbusiness Organizations SFAC No.5 - Recognition and Measurement in Financial Statements SFAC No.6 - Elements of Financial Statements (replaces SFAC No. 3) SFAC No.7 - Using Cash Flow Information and Present Value in Accounting Measurements LO 2 Describe the FASB’s efforts to construct a conceptual framework. LO 2 Describe the FASB’s efforts to construct a conceptual framework.
Chapter 2-8 The Framework is comprised of three levels: First Level = Basic Objectives Second Level = Qualitative Characteristics and Basic Elements Third Level = Recognition and Measurement Concepts. Conceptual Framework Conceptual Framework LO 2 Describe the FASB’s efforts to construct a conceptual framework. LO 2 Describe the FASB’s efforts to construct a conceptual framework.
Chapter 2-9 ASSUMPTIONS ASSUMPTIONS 1. 1. Economic entity Economic entity 2. 2. Going concern Going concern 3. 3. Monetary unit Monetary unit 4. 4. Periodicity Periodicity PRINCIPLES PRINCIPLES 1. 1. Historical cost Historical cost 2. 2. Revenue recognition Revenue recognition 3. 3. Matching Matching 4. 4. Full disclosure Full disclosure CONSTRAINTS CONSTRAINTS 1. 1. Cost-benefit Cost-benefit 2. 2. Materiality Materiality 3. 3. Industry practice Industry practice 4. 4. Conservatism Conservatism OBJECTIVES OBJECTIVES 1. 1. Useful in investment Useful in investment and credit decisions and credit decisions 2. 2. Useful in assessing Useful in assessing future cash flows future cash flows 3. About enterprise 3. About enterprise resources, claims to resources, claims to resources, and resources, and changes in them changes in them ELEMENTS ELEMENTS Assets, Liabilities, and Equity Assets, Liabilities, and Equity Investments by owners Investments by owners Distribution to owners Distribution to owners Comprehensive income Comprehensive income Revenues and Expenses Revenues and Expenses Gains and Losses Gains and Losses Illustration 2-6 Illustration 2-6 Conceptual Framework for Financial Reporting First level Second level Third level LO 2 Describe the FASB’s LO 2 Describe the FASB’s efforts to construct a efforts to construct a conceptual framework. conceptual framework. QUALITATIVE QUALITATIVE CHARACTERISTICS CHARACTERISTICS Relevance Relevance Reliability Reliability Comparability Comparability Consistency Consistency
Chapter 2-10 What are the Statements of Financial Accounting What are the Statements of Financial Accounting Concepts intended to establish? Concepts intended to establish? a. a. Generally accepted accounting principles in Generally accepted accounting principles in financial reporting by business enterprises. financial reporting by business enterprises. b. b. The meaning of “Present fairly in accordance with The meaning of “Present fairly in accordance with generally accepted accounting principles.” generally accepted accounting principles.” c. c. The objectives and concepts for use in developing The objectives and concepts for use in developing standards of financial accounting and reporting. standards of financial accounting and reporting. d. d. The hierarchy of sources of generally accepted The hierarchy of sources of generally accepted accounting principles. accounting principles. Conceptual Framework Conceptual Framework LO 2 Describe the FASB’s efforts to construct a conceptual framework. LO 2 Describe the FASB’s efforts to construct a conceptual framework. Review: Review: (CPA adapted) (CPA adapted)
Chapter 2-11 Financial reporting should provide information that: Financial reporting should provide information that: (a) is useful to present and potential investors and creditors (a) is useful to present and potential investors and creditors and other users in making rational investment, credit, and and other users in making rational investment, credit, and similar decisions. similar decisions. (b) helps present and potential investors and creditors and (b) helps present and potential investors and creditors and other users in assessing the amounts, timing, and other users in assessing the amounts, timing, and uncertainty of prospective cash receipts. uncertainty of prospective cash receipts. (c) portrays the economic resources of an enterprise, the (c) portrays the economic resources of an enterprise, the claims to those resources, and the effects of claims to those resources, and the effects of transactions, events, and circumstances that change its transactions, events, and circumstances that change its resources and claims to those resources. resources and claims to those resources. First Level: Basic Objectives First Level: Basic Objectives LO 3 Understand the objectives of financial reporting. LO 3 Understand the objectives of financial reporting.
Chapter 2-12 According to the FASB conceptual framework, the According to the FASB conceptual framework, the objectives of financial reporting for business objectives of financial reporting for business enterprises are based on? enterprises are based on? a. a. Generally accepted accounting principles Generally accepted accounting principles b. b. Reporting on management’s stewardship. Reporting on management’s stewardship. c. c. The need for conservatism. The need for conservatism. d. d. The needs of the users of the information. The needs of the users of the information. Conceptual Framework Conceptual Framework LO 3 Understand the objectives of financial reporting. LO 3 Understand the objectives of financial reporting. (CPA adapted) (CPA adapted) Review: Review:
Chapter 2-13 Question: How does a company choose an acceptable accounting method, the amount and types of information to disclose, and the format in which to present it? Second Level: Fundamental Concepts Second Level: Fundamental Concepts LO 4 Identify the qualitative characteristics of accounting information. 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).
Chapter 2-14 Qualitative Characteristics “The FASB identified the Qualitative Characteristics of accounting information that distinguish better (more useful) information from inferior (less useful) information for decision-making purposes.” Second Level: Fundamental Concepts Second Level: Fundamental Concepts LO 4 Identify the qualitative characteristics of accounting information. LO 4 Identify the qualitative characteristics of accounting information.
Chapter 2-15 Second Level: Qualitative Characteristics Second Level: Qualitative Characteristics LO 4 Identify the qualitative characteristics of accounting information. LO 4 Identify the qualitative characteristics of accounting information. Illustration 2-2 Illustration 2-2 Hierarchy of Accounting Qualities
Chapter 2-16 Understandability A company may present highly relevant and reliable information, however it was useless to those who do not understand it. Second Level: Fundamental Concepts Second Level: Fundamental Concepts LO 4 Identify the qualitative characteristics of accounting information. LO 4 Identify the qualitative characteristics of accounting information.
Chapter 2-17 ASSUMPTIONS ASSUMPTIONS 1. 1. Economic entity Economic entity 2. 2. Going concern Going concern 3. 3. Monetary unit Monetary unit 4. 4. Periodicity Periodicity PRINCIPLES PRINCIPLES 1. 1. Historical cost Historical cost 2. 2. Revenue recognition Revenue recognition 3. 3. Matching Matching 4. 4. Full disclosure Full disclosure CONSTRAINTS CONSTRAINTS 1. 1. Cost-benefit Cost-benefit 2. 2. Materiality Materiality 3. 3. Industry practice Industry practice 4. 4. Conservatism Conservatism OBJECTIVES OBJECTIVES 1. 1. Useful in investment Useful in investment and credit decisions and credit decisions 2. 2. Useful in assessing Useful in assessing future cash flows future cash flows 3. About enterprise 3. About enterprise resources, claims to resources, claims to resources, and resources, and changes in them changes in them QUALITATIVE QUALITATIVE CHARACTERISTICS CHARACTERISTICS Relevance Relevance Reliability Reliability Comparability Comparability Consistency Consistency ELEMENTS ELEMENTS Assets, Liabilities, and Equity Assets, Liabilities, and Equity Investments by owners Investments by owners Distribution to owners Distribution to owners Comprehensive income Comprehensive income Revenues and Expenses Revenues and Expenses Gains and Losses Gains and Losses Illustration 2-6 Illustration 2-6 Conceptual Framework for Financial Reporting First level Second level Third level Relevance and Reliability Relevance and Reliability LO 4 Identify the qualitative LO 4 Identify the qualitative characteristics of characteristics of accounting information. accounting information.
Chapter 2-18 LO 4 Identify the qualitative characteristics of accounting information. LO 4 Identify the qualitative characteristics of accounting information. Second Level: Qualitative Characteristics Second Level: Qualitative Characteristics Primary Qualities: Relevance – making a difference in a decision. Predictive value Feedback value Timeliness Reliability Verifiable Representational faithfulness Neutral - free of error and bias
Chapter 2-19 Review: Review: LO 4 Identify the qualitative characteristics of accounting information. LO 4 Identify the qualitative characteristics of accounting information. Relevance and reliability are the two primary Relevance and reliability are the two primary qualities that make accounting information useful qualities that make accounting information useful for decision making. for decision making. To be reliable, accounting information must be To be reliable, accounting information must be capable of making a difference in a decision. capable of making a difference in a decision. True True False False Second Level: Qualitative Characteristics Second Level: Qualitative Characteristics
Chapter 2-20 ASSUMPTIONS ASSUMPTIONS 1. 1. Economic entity Economic entity 2. 2. Going concern Going concern 3. 3. Monetary unit Monetary unit 4. 4. Periodicity Periodicity PRINCIPLES PRINCIPLES 1. 1. Historical cost Historical cost 2. 2. Revenue recognition Revenue recognition 3. 3. Matching Matching 4. 4. Full disclosure Full disclosure CONSTRAINTS CONSTRAINTS 1. 1. Cost-benefit Cost-benefit 2. 2. Materiality Materiality 3. 3. Industry practice Industry practice 4. 4. Conservatism Conservatism OBJECTIVES OBJECTIVES 1. 1. Useful in investment Useful in investment and credit decisions and credit decisions 2. 2. Useful in assessing Useful in assessing future cash flows future cash flows 3. About enterprise 3. About enterprise resources, claims to resources, claims to resources, and resources, and changes in them changes in them QUALITATIVE QUALITATIVE CHARACTERISTICS CHARACTERISTICS Relevance Relevance Reliability Reliability Comparability Comparability Consistency Consistency ELEMENTS ELEMENTS Assets, Liabilities, and Equity Assets, Liabilities, and Equity Investments by owners Investments by owners Distribution to owners Distribution to owners Comprehensive income Comprehensive income Revenues and Expenses Revenues and Expenses Gains and Losses Gains and Losses Illustration 2-6 Illustration 2-6 Conceptual Framework for Financial Reporting First level Second level Third level LO 4 Identify the qualitative LO 4 Identify the qualitative characteristics of characteristics of accounting information. accounting information. Comparability and Consistency Comparability and Consistency
Chapter 2-21 LO 4 Identify the qualitative characteristics of accounting information. LO 4 Identify the qualitative characteristics of accounting information. Second Level: Qualitative Characteristics Second Level: Qualitative Characteristics Secondary Qualities: Comparability – Information 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 period to period.
Chapter 2-22 Review: Review: LO 4 Identify the qualitative characteristics of accounting information. LO 4 Identify the qualitative characteristics of accounting information. Adherence to the concept of consistency Adherence to the concept of consistency requires that the same accounting principles be requires that the same accounting principles be applied to similar transactions for a minimum of applied to similar transactions for a minimum of five years before any change in principle is five years before any change in principle is adopted. adopted. False False Second Level: Qualitative Characteristics Second Level: Qualitative Characteristics
Chapter 2-23 ASSUMPTIONS ASSUMPTIONS 1. 1. Economic entity Economic entity 2. 2. Going concern Going concern 3. 3. Monetary unit Monetary unit 4. 4. Periodicity Periodicity PRINCIPLES PRINCIPLES 1. 1. Historical cost Historical cost 2. 2. Revenue recognition Revenue recognition 3. 3. Matching Matching 4. 4. Full disclosure Full disclosure CONSTRAINTS CONSTRAINTS 1. 1. Cost-benefit Cost-benefit 2. 2. Materiality Materiality 3. 3. Industry practice Industry practice 4. 4. Conservatism Conservatism OBJECTIVES OBJECTIVES 1. 1. Useful in investment Useful in investment and credit decisions and credit decisions 2. 2. Useful in assessing Useful in assessing future cash flows future cash flows 3. About enterprise 3. About enterprise resources, claims to resources, claims to resources, and resources, and changes in them changes in them QUALITATIVE QUALITATIVE CHARACTERISTICS CHARACTERISTICS Relevance Relevance Reliability Reliability Comparability Comparability Consistency Consistency ELEMENTS ELEMENTS Assets, Liabilities, and Equity Assets, Liabilities, and Equity Investments by owners Investments by owners Distribution to owners Distribution to owners Comprehensive income Comprehensive income Revenues and Expenses Revenues and Expenses Gains and Losses Gains and Losses Illustration 2-6 Illustration 2-6 Conceptual Framework for Financial Reporting First level Second level Third level Elements Elements LO 5 Define the basic LO 5 Define the basic elements of financial elements of financial statements. statements.
Chapter 2-24 Investment by owners Investment by owners Distribution to owners Distribution to owners Comprehensive income Comprehensive income Revenue Revenue Expenses Expenses Gains Gains Losses Losses Second Level: Elements Second Level: Elements Concepts Statement No. 6 defines ten interrelated elements that relate to measuring the performance and financial status of a business enterprise. Assets Assets Liabilities Liabilities Equity Equity “Moment in Time” “Period of Time” LO 5 Define the basic elements of financial statements. LO 5 Define the basic elements of financial statements.
Chapter 2-25 Second Level: Elements Second Level: Elements Exercise 2-3 Identify the element or elements associated with items below. (a) Arises from peripheral or (a) Arises from peripheral or incidental transactions. incidental transactions. (b) Obligation to transfer (b) Obligation to transfer resources arising from a resources arising from a past transaction. past transaction. (c) Increases ownership (c) Increases ownership interest. interest. (d) Declares and pays cash (d) Declares and pays cash dividends to owners. dividends to owners. (e) Increases in net assets in a (e) Increases in net assets in a period from nonowner period from nonowner sources. sources. LO 5 Define the basic elements of financial statements. LO 5 Define the basic elements of financial statements. (a) Elements (b) (c) (d) (c) (a) (e) Assets Assets Liabilities Liabilities Equity Equity Investment by owners Investment by owners Distribution to owners Distribution to owners Comprehensive income Comprehensive income Revenue Revenue Expenses Expenses Gains Gains Losses Losses
Chapter 2-26 (g) Second Level: Elements Second Level: Elements Exercise 2-3 Identify the element or elements associated with items below. (f) (f) Items characterized by Items characterized by future economic benefit. future economic benefit. (g) (g) Equals increase in net Equals increase in net assets during the year, assets during the year, after adding distributions after adding distributions to owners and subtracting to owners and subtracting investments by owners. investments by owners. (h) (h) Arises from income Arises from income statement activities that statement activities that constitute the entity’s constitute the entity’s ongoing major or central ongoing major or central operations. operations. LO 5 Define the basic elements of financial statements. LO 5 Define the basic elements of financial statements. (a) Elements (b) (d) (c) (a) (f) (e) (h) (c) (h) Assets Assets Liabilities Liabilities Equity Equity Investment by owners Investment by owners Distribution to owners Distribution to owners Comprehensive income Comprehensive income Revenue Revenue Expenses Expenses Gains Gains Losses Losses
Chapter 2-27 (g) Assets Assets Liabilities Liabilities Equity Equity Investment by owners Investment by owners Distribution to owners Distribution to owners Comprehensive income Comprehensive income Revenue Revenue Expenses Expenses Gains Gains Losses Losses Second Level: Elements Second Level: Elements Exercise 2-3 Identify the element or elements associated with items below. (i) (i) Residual interest in the net Residual interest in the net assets of the enterprise. assets of the enterprise. (j) (j) Increases assets through Increases assets through sale of product. sale of product. (k) (k) Decreases assets by Decreases assets by purchasing the company’s purchasing the company’s own stock. own stock. (l) (l) Changes in equity during Changes in equity during the period, except those the period, except those from investments by from investments by owners and distributions to owners and distributions to owners. owners. LO 5 Define the basic elements of financial statements. LO 5 Define the basic elements of financial statements. (a) Elements (b) (d) (c) (a) (f) (e) (h) (c) (h) (i) (j) (k) (l)
Chapter 2-28 Review: Review: Second Level: Elements Second Level: Elements According to the FASB conceptual framework, an According to the FASB conceptual framework, an entity’s revenue may result from entity’s revenue may result from a. a. A decrease in an asset from primary operations. A decrease in an asset from primary operations. b. b. An increase in an asset from incidental An increase in an asset from incidental transactions. transactions. c. c. An increase in a liability from incidental An increase in a liability from incidental transactions. transactions. d. d. A decrease in a liability from primary operations. A decrease in a liability from primary operations. LO 5 Define the basic elements of financial statements. LO 5 Define the basic elements of financial statements. (CPA adapted) (CPA adapted)
Chapter 2-29 Third Level: Recognition and Measurement Third Level: Recognition and Measurement The FASB sets forth most of these concepts in its Statement of Financial Accounting Concepts No. 5, “Recognition and Measurement in Financial Statements of Business Enterprises.” ASSUMPTIONS ASSUMPTIONS 1. 1. Economic entity Economic entity 2. 2. Going concern Going concern 3. 3. Monetary unit Monetary unit 4. 4. Periodicity Periodicity PRINCIPLES PRINCIPLES 1. 1. Historical cost Historical cost 2. 2. Revenue recognition Revenue recognition 3. 3. Matching Matching 4. 4. Full disclosure Full disclosure CONSTRAINTS CONSTRAINTS 1. 1. Cost-benefit Cost-benefit 2. 2. Materiality Materiality 3. 3. Industry practice Industry practice 4. 4. Conservatism Conservatism LO 6 Describe the basic assumptions of accounting. LO 6 Describe the basic assumptions of accounting.
Chapter 2-30 Economic Entity – company keeps its activity separate 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 Third Level: Assumptions LO 6 Describe the basic assumptions of accounting. LO 6 Describe the basic assumptions of accounting.
Chapter 2-31 Third Level: Assumptions Third Level: Assumptions LO 6 Describe the basic assumptions of accounting. LO 6 Describe the basic assumptions of accounting. Brief Exercise 2-4 Identify which basic assumption of accounting is best described in each item below. (a) The economic activities of FedEx Corporation are divided into 12-month periods for the purpose of issuing annual reports. (b) Solectron Corporation, Inc. does not adjust amounts in its financial statements for the effects 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 for accounting and reporting purposes. Periodicity Periodicity Going Concern Going Concern Monetary Monetary Unit Unit Economic Economic Entity Entity
Chapter 2-32 Historical Cost – the price, established by the exchange transaction, is the “cost”. Issues: Historical cost provides a reliable benchmark for measuring 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 Third Level: Principles LO 7 Explain the application of the basic principles of accounting. LO 7 Explain the application of the basic principles of accounting.
Chapter 2-33 Revenue Recognition - generally occurs (1) when realized or realizable and (2) when earned. Exceptions: During Production. At End of Production Upon Receipt of Cash Third Level: Principles Third Level: Principles LO 7 Explain the application of the basic principles of accounting. LO 7 Explain the application of the basic principles of accounting.
Chapter 2-34 Matching - efforts (expenses) should be matched with accomplishment (revenues) whenever it is reasonable and practicable to do so. “Let the expense follow the revenues.” Third Level: Principles Third Level: Principles LO 7 Explain the application of the basic principles of accounting. LO 7 Explain the application of the basic principles of accounting. Illustration 2-4 Illustration 2-4 Expense Recognition
Chapter 2-35 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 Third Level: Principles Third Level: Principles LO 7 Explain the application of the basic principles of accounting. LO 7 Explain the application of the basic principles of accounting.
Chapter 2-36 Third Level: Principles Third Level: Principles LO 7 Explain the application of the basic principles of accounting. LO 7 Explain the application of the basic principles of accounting. Brief Exercise 2-5 Identify which basic principle of accounting is best described in each item below. (a) Norfolk Southern Corporation reports revenue in its income statement when it is earned instead of when the cash is collected. (b) Yahoo, Inc. recognizes depreciation expense for a machine over the 2-year period during which that machine helps the company earn revenue. (c) Oracle Corporation reports information about pending lawsuits in the notes to its financial statements. (d) Eastman Kodak Company reports land on its balance sheet at the amount paid to acquire it, even though the estimated fair market value is greater. Revenue Revenue Recognition Recognition Matching Matching Full Full Disclosure Disclosure Historical Historical Cost Cost
Chapter 2-37 Cost Benefit – 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. Industry Practice - the peculiar nature of some industries and business concerns sometimes requires departure from basic accounting theory. Conservatism – when in doubt, choose the solution that will be least likely to overstate assets and income. Third Level: Constraints Third Level: Constraints LO 8 Describe the impact that constraints have LO 8 Describe the impact that constraints have on reporting accounting information. on reporting accounting information.
Chapter 2-38 Brief Exercise 2-6 What accounting constraints are illustrated by the items below? (a) Zip’s Farms, Inc. reports agricultural crops on its balance sheet at market value. (b) Crimson Tide Corporation does not accrue a contingent lawsuit gain of $650,000. (c) Wildcat Company does not disclose any information in the notes to the financial statements unless the value of the information to users exceeds the expense of gathering it. (d) Sun Devil Corporation expenses the cost of wastebaskets in the year they are acquired. Industry Industry Practice Practice Conservatism Conservatism Third Level: Constraints Third Level: Constraints Cost-Benefit Cost-Benefit Materiality Materiality LO 8 Describe the impact that constraints have LO 8 Describe the impact that constraints have on reporting accounting information. on reporting accounting information.
Chapter 2-39 Copyright © 2006 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein. Copyright Copyright

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ch02.ppt Conceptual Framework Underlying Financial Accounting

  • 1. Chapter 2-1 Conceptual Framework Conceptual Framework Underlying Financial Accounting Underlying Financial Accounting Chapter Chapter 2 2 Intermediate Accounting 12th Edition Kieso, Weygandt, and Warfield Prepared by Coby Harmon, University of California, Santa Barbara
  • 2. Chapter 2-2 1. 1. Describe the usefulness of a conceptual framework. Describe the usefulness of a conceptual framework. 2. 2. Describe the FASB’s efforts to construct a conceptual Describe the FASB’s efforts to construct a conceptual framework. framework. 3. 3. Understand the objectives of financial reporting. Understand the objectives of financial reporting. 4. 4. Identify the qualitative characteristics of accounting Identify the qualitative characteristics of accounting information. information. 5. 5. Define the basic elements of financial statements. Define the basic elements of financial statements. 6. 6. Describe the basic assumptions of accounting. Describe the basic assumptions of accounting. 7. 7. Explain the application of the basic principles of Explain the application of the basic principles of accounting. accounting. 8. 8. Describe the impact that constraints have on reporting Describe the impact that constraints have on reporting accounting information. accounting information. Chapter 2 Learning Objectives Chapter 2 Learning Objectives
  • 3. Chapter 2-3 Conceptual Conceptual Framework Framework Need Need Development Development First Level: First Level: Basic Basic Objectives Objectives Second Level: Second Level: Fundamental Fundamental Concepts Concepts Third Level: Third Level: Recognition and Recognition and Measurement Measurement Basic Basic assumptions assumptions Basic principles Basic principles Constraints Constraints Qualitative Qualitative characteristics characteristics Basic elements Basic elements Conceptual Framework Conceptual Framework
  • 4. Chapter 2-4 The Need for a Conceptual Framework To develop a coherent set of standards and rules To solve new and emerging practical problems Conceptual Framework Conceptual Framework LO 1 Describe the usefulness of a conceptual framework. LO 1 Describe the usefulness of a conceptual framework.
  • 5. Chapter 2-5 Review: Review: conceptual framework underlying financial conceptual framework underlying financial accounting is important because it can lead to accounting is important because it can lead to consistent standards and it prescribes the consistent standards and it prescribes the nature, function, and limits of financial nature, function, and limits of financial accounting and financial statements. accounting and financial statements. Conceptual Framework Conceptual Framework LO 1 Describe the usefulness of a conceptual framework. LO 1 Describe the usefulness of a conceptual framework. True True
  • 6. Chapter 2-6 Review: Review: A conceptual framework underlying financial A conceptual framework underlying financial accounting is necessary because future accounting is necessary because future accounting practice problems can be solved by accounting practice problems can be solved by reference to the conceptual framework and a reference to the conceptual framework and a formal standard-setting body will not be formal standard-setting body will not be necessary. necessary. Conceptual Framework Conceptual Framework LO 1 Describe the usefulness of a conceptual framework. LO 1 Describe the usefulness of a conceptual framework. False False
  • 7. Chapter 2-7 Objective 2 Objective 2 The FASB has issued six Statements of Financial Accounting Concepts (SFAC) for business enterprises. Development of Conceptual Framework Development of Conceptual Framework SFAC No.1 - Objectives of Financial Reporting SFAC No.2 - Qualitative Characteristics of Accounting Information SFAC No.3 - Elements of Financial Statements (superceded by SFAC No. 6) SFAC No.4 - Nonbusiness Organizations SFAC No.5 - Recognition and Measurement in Financial Statements SFAC No.6 - Elements of Financial Statements (replaces SFAC No. 3) SFAC No.7 - Using Cash Flow Information and Present Value in Accounting Measurements LO 2 Describe the FASB’s efforts to construct a conceptual framework. LO 2 Describe the FASB’s efforts to construct a conceptual framework.
  • 8. Chapter 2-8 The Framework is comprised of three levels: First Level = Basic Objectives Second Level = Qualitative Characteristics and Basic Elements Third Level = Recognition and Measurement Concepts. Conceptual Framework Conceptual Framework LO 2 Describe the FASB’s efforts to construct a conceptual framework. LO 2 Describe the FASB’s efforts to construct a conceptual framework.
  • 9. Chapter 2-9 ASSUMPTIONS ASSUMPTIONS 1. 1. Economic entity Economic entity 2. 2. Going concern Going concern 3. 3. Monetary unit Monetary unit 4. 4. Periodicity Periodicity PRINCIPLES PRINCIPLES 1. 1. Historical cost Historical cost 2. 2. Revenue recognition Revenue recognition 3. 3. Matching Matching 4. 4. Full disclosure Full disclosure CONSTRAINTS CONSTRAINTS 1. 1. Cost-benefit Cost-benefit 2. 2. Materiality Materiality 3. 3. Industry practice Industry practice 4. 4. Conservatism Conservatism OBJECTIVES OBJECTIVES 1. 1. Useful in investment Useful in investment and credit decisions and credit decisions 2. 2. Useful in assessing Useful in assessing future cash flows future cash flows 3. About enterprise 3. About enterprise resources, claims to resources, claims to resources, and resources, and changes in them changes in them ELEMENTS ELEMENTS Assets, Liabilities, and Equity Assets, Liabilities, and Equity Investments by owners Investments by owners Distribution to owners Distribution to owners Comprehensive income Comprehensive income Revenues and Expenses Revenues and Expenses Gains and Losses Gains and Losses Illustration 2-6 Illustration 2-6 Conceptual Framework for Financial Reporting First level Second level Third level LO 2 Describe the FASB’s LO 2 Describe the FASB’s efforts to construct a efforts to construct a conceptual framework. conceptual framework. QUALITATIVE QUALITATIVE CHARACTERISTICS CHARACTERISTICS Relevance Relevance Reliability Reliability Comparability Comparability Consistency Consistency
  • 10. Chapter 2-10 What are the Statements of Financial Accounting What are the Statements of Financial Accounting Concepts intended to establish? Concepts intended to establish? a. a. Generally accepted accounting principles in Generally accepted accounting principles in financial reporting by business enterprises. financial reporting by business enterprises. b. b. The meaning of “Present fairly in accordance with The meaning of “Present fairly in accordance with generally accepted accounting principles.” generally accepted accounting principles.” c. c. The objectives and concepts for use in developing The objectives and concepts for use in developing standards of financial accounting and reporting. standards of financial accounting and reporting. d. d. The hierarchy of sources of generally accepted The hierarchy of sources of generally accepted accounting principles. accounting principles. Conceptual Framework Conceptual Framework LO 2 Describe the FASB’s efforts to construct a conceptual framework. LO 2 Describe the FASB’s efforts to construct a conceptual framework. Review: Review: (CPA adapted) (CPA adapted)
  • 11. Chapter 2-11 Financial reporting should provide information that: Financial reporting should provide information that: (a) is useful to present and potential investors and creditors (a) is useful to present and potential investors and creditors and other users in making rational investment, credit, and and other users in making rational investment, credit, and similar decisions. similar decisions. (b) helps present and potential investors and creditors and (b) helps present and potential investors and creditors and other users in assessing the amounts, timing, and other users in assessing the amounts, timing, and uncertainty of prospective cash receipts. uncertainty of prospective cash receipts. (c) portrays the economic resources of an enterprise, the (c) portrays the economic resources of an enterprise, the claims to those resources, and the effects of claims to those resources, and the effects of transactions, events, and circumstances that change its transactions, events, and circumstances that change its resources and claims to those resources. resources and claims to those resources. First Level: Basic Objectives First Level: Basic Objectives LO 3 Understand the objectives of financial reporting. LO 3 Understand the objectives of financial reporting.
  • 12. Chapter 2-12 According to the FASB conceptual framework, the According to the FASB conceptual framework, the objectives of financial reporting for business objectives of financial reporting for business enterprises are based on? enterprises are based on? a. a. Generally accepted accounting principles Generally accepted accounting principles b. b. Reporting on management’s stewardship. Reporting on management’s stewardship. c. c. The need for conservatism. The need for conservatism. d. d. The needs of the users of the information. The needs of the users of the information. Conceptual Framework Conceptual Framework LO 3 Understand the objectives of financial reporting. LO 3 Understand the objectives of financial reporting. (CPA adapted) (CPA adapted) Review: Review:
  • 13. Chapter 2-13 Question: How does a company choose an acceptable accounting method, the amount and types of information to disclose, and the format in which to present it? Second Level: Fundamental Concepts Second Level: Fundamental Concepts LO 4 Identify the qualitative characteristics of accounting information. 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).
  • 14. Chapter 2-14 Qualitative Characteristics “The FASB identified the Qualitative Characteristics of accounting information that distinguish better (more useful) information from inferior (less useful) information for decision-making purposes.” Second Level: Fundamental Concepts Second Level: Fundamental Concepts LO 4 Identify the qualitative characteristics of accounting information. LO 4 Identify the qualitative characteristics of accounting information.
  • 15. Chapter 2-15 Second Level: Qualitative Characteristics Second Level: Qualitative Characteristics LO 4 Identify the qualitative characteristics of accounting information. LO 4 Identify the qualitative characteristics of accounting information. Illustration 2-2 Illustration 2-2 Hierarchy of Accounting Qualities
  • 16. Chapter 2-16 Understandability A company may present highly relevant and reliable information, however it was useless to those who do not understand it. Second Level: Fundamental Concepts Second Level: Fundamental Concepts LO 4 Identify the qualitative characteristics of accounting information. LO 4 Identify the qualitative characteristics of accounting information.
  • 17. Chapter 2-17 ASSUMPTIONS ASSUMPTIONS 1. 1. Economic entity Economic entity 2. 2. Going concern Going concern 3. 3. Monetary unit Monetary unit 4. 4. Periodicity Periodicity PRINCIPLES PRINCIPLES 1. 1. Historical cost Historical cost 2. 2. Revenue recognition Revenue recognition 3. 3. Matching Matching 4. 4. Full disclosure Full disclosure CONSTRAINTS CONSTRAINTS 1. 1. Cost-benefit Cost-benefit 2. 2. Materiality Materiality 3. 3. Industry practice Industry practice 4. 4. Conservatism Conservatism OBJECTIVES OBJECTIVES 1. 1. Useful in investment Useful in investment and credit decisions and credit decisions 2. 2. Useful in assessing Useful in assessing future cash flows future cash flows 3. About enterprise 3. About enterprise resources, claims to resources, claims to resources, and resources, and changes in them changes in them QUALITATIVE QUALITATIVE CHARACTERISTICS CHARACTERISTICS Relevance Relevance Reliability Reliability Comparability Comparability Consistency Consistency ELEMENTS ELEMENTS Assets, Liabilities, and Equity Assets, Liabilities, and Equity Investments by owners Investments by owners Distribution to owners Distribution to owners Comprehensive income Comprehensive income Revenues and Expenses Revenues and Expenses Gains and Losses Gains and Losses Illustration 2-6 Illustration 2-6 Conceptual Framework for Financial Reporting First level Second level Third level Relevance and Reliability Relevance and Reliability LO 4 Identify the qualitative LO 4 Identify the qualitative characteristics of characteristics of accounting information. accounting information.
  • 18. Chapter 2-18 LO 4 Identify the qualitative characteristics of accounting information. LO 4 Identify the qualitative characteristics of accounting information. Second Level: Qualitative Characteristics Second Level: Qualitative Characteristics Primary Qualities: Relevance – making a difference in a decision. Predictive value Feedback value Timeliness Reliability Verifiable Representational faithfulness Neutral - free of error and bias
  • 19. Chapter 2-19 Review: Review: LO 4 Identify the qualitative characteristics of accounting information. LO 4 Identify the qualitative characteristics of accounting information. Relevance and reliability are the two primary Relevance and reliability are the two primary qualities that make accounting information useful qualities that make accounting information useful for decision making. for decision making. To be reliable, accounting information must be To be reliable, accounting information must be capable of making a difference in a decision. capable of making a difference in a decision. True True False False Second Level: Qualitative Characteristics Second Level: Qualitative Characteristics
  • 20. Chapter 2-20 ASSUMPTIONS ASSUMPTIONS 1. 1. Economic entity Economic entity 2. 2. Going concern Going concern 3. 3. Monetary unit Monetary unit 4. 4. Periodicity Periodicity PRINCIPLES PRINCIPLES 1. 1. Historical cost Historical cost 2. 2. Revenue recognition Revenue recognition 3. 3. Matching Matching 4. 4. Full disclosure Full disclosure CONSTRAINTS CONSTRAINTS 1. 1. Cost-benefit Cost-benefit 2. 2. Materiality Materiality 3. 3. Industry practice Industry practice 4. 4. Conservatism Conservatism OBJECTIVES OBJECTIVES 1. 1. Useful in investment Useful in investment and credit decisions and credit decisions 2. 2. Useful in assessing Useful in assessing future cash flows future cash flows 3. About enterprise 3. About enterprise resources, claims to resources, claims to resources, and resources, and changes in them changes in them QUALITATIVE QUALITATIVE CHARACTERISTICS CHARACTERISTICS Relevance Relevance Reliability Reliability Comparability Comparability Consistency Consistency ELEMENTS ELEMENTS Assets, Liabilities, and Equity Assets, Liabilities, and Equity Investments by owners Investments by owners Distribution to owners Distribution to owners Comprehensive income Comprehensive income Revenues and Expenses Revenues and Expenses Gains and Losses Gains and Losses Illustration 2-6 Illustration 2-6 Conceptual Framework for Financial Reporting First level Second level Third level LO 4 Identify the qualitative LO 4 Identify the qualitative characteristics of characteristics of accounting information. accounting information. Comparability and Consistency Comparability and Consistency
  • 21. Chapter 2-21 LO 4 Identify the qualitative characteristics of accounting information. LO 4 Identify the qualitative characteristics of accounting information. Second Level: Qualitative Characteristics Second Level: Qualitative Characteristics Secondary Qualities: Comparability – Information 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 period to period.
  • 22. Chapter 2-22 Review: Review: LO 4 Identify the qualitative characteristics of accounting information. LO 4 Identify the qualitative characteristics of accounting information. Adherence to the concept of consistency Adherence to the concept of consistency requires that the same accounting principles be requires that the same accounting principles be applied to similar transactions for a minimum of applied to similar transactions for a minimum of five years before any change in principle is five years before any change in principle is adopted. adopted. False False Second Level: Qualitative Characteristics Second Level: Qualitative Characteristics
  • 23. Chapter 2-23 ASSUMPTIONS ASSUMPTIONS 1. 1. Economic entity Economic entity 2. 2. Going concern Going concern 3. 3. Monetary unit Monetary unit 4. 4. Periodicity Periodicity PRINCIPLES PRINCIPLES 1. 1. Historical cost Historical cost 2. 2. Revenue recognition Revenue recognition 3. 3. Matching Matching 4. 4. Full disclosure Full disclosure CONSTRAINTS CONSTRAINTS 1. 1. Cost-benefit Cost-benefit 2. 2. Materiality Materiality 3. 3. Industry practice Industry practice 4. 4. Conservatism Conservatism OBJECTIVES OBJECTIVES 1. 1. Useful in investment Useful in investment and credit decisions and credit decisions 2. 2. Useful in assessing Useful in assessing future cash flows future cash flows 3. About enterprise 3. About enterprise resources, claims to resources, claims to resources, and resources, and changes in them changes in them QUALITATIVE QUALITATIVE CHARACTERISTICS CHARACTERISTICS Relevance Relevance Reliability Reliability Comparability Comparability Consistency Consistency ELEMENTS ELEMENTS Assets, Liabilities, and Equity Assets, Liabilities, and Equity Investments by owners Investments by owners Distribution to owners Distribution to owners Comprehensive income Comprehensive income Revenues and Expenses Revenues and Expenses Gains and Losses Gains and Losses Illustration 2-6 Illustration 2-6 Conceptual Framework for Financial Reporting First level Second level Third level Elements Elements LO 5 Define the basic LO 5 Define the basic elements of financial elements of financial statements. statements.
  • 24. Chapter 2-24 Investment by owners Investment by owners Distribution to owners Distribution to owners Comprehensive income Comprehensive income Revenue Revenue Expenses Expenses Gains Gains Losses Losses Second Level: Elements Second Level: Elements Concepts Statement No. 6 defines ten interrelated elements that relate to measuring the performance and financial status of a business enterprise. Assets Assets Liabilities Liabilities Equity Equity “Moment in Time” “Period of Time” LO 5 Define the basic elements of financial statements. LO 5 Define the basic elements of financial statements.
  • 25. Chapter 2-25 Second Level: Elements Second Level: Elements Exercise 2-3 Identify the element or elements associated with items below. (a) Arises from peripheral or (a) Arises from peripheral or incidental transactions. incidental transactions. (b) Obligation to transfer (b) Obligation to transfer resources arising from a resources arising from a past transaction. past transaction. (c) Increases ownership (c) Increases ownership interest. interest. (d) Declares and pays cash (d) Declares and pays cash dividends to owners. dividends to owners. (e) Increases in net assets in a (e) Increases in net assets in a period from nonowner period from nonowner sources. sources. LO 5 Define the basic elements of financial statements. LO 5 Define the basic elements of financial statements. (a) Elements (b) (c) (d) (c) (a) (e) Assets Assets Liabilities Liabilities Equity Equity Investment by owners Investment by owners Distribution to owners Distribution to owners Comprehensive income Comprehensive income Revenue Revenue Expenses Expenses Gains Gains Losses Losses
  • 26. Chapter 2-26 (g) Second Level: Elements Second Level: Elements Exercise 2-3 Identify the element or elements associated with items below. (f) (f) Items characterized by Items characterized by future economic benefit. future economic benefit. (g) (g) Equals increase in net Equals increase in net assets during the year, assets during the year, after adding distributions after adding distributions to owners and subtracting to owners and subtracting investments by owners. investments by owners. (h) (h) Arises from income Arises from income statement activities that statement activities that constitute the entity’s constitute the entity’s ongoing major or central ongoing major or central operations. operations. LO 5 Define the basic elements of financial statements. LO 5 Define the basic elements of financial statements. (a) Elements (b) (d) (c) (a) (f) (e) (h) (c) (h) Assets Assets Liabilities Liabilities Equity Equity Investment by owners Investment by owners Distribution to owners Distribution to owners Comprehensive income Comprehensive income Revenue Revenue Expenses Expenses Gains Gains Losses Losses
  • 27. Chapter 2-27 (g) Assets Assets Liabilities Liabilities Equity Equity Investment by owners Investment by owners Distribution to owners Distribution to owners Comprehensive income Comprehensive income Revenue Revenue Expenses Expenses Gains Gains Losses Losses Second Level: Elements Second Level: Elements Exercise 2-3 Identify the element or elements associated with items below. (i) (i) Residual interest in the net Residual interest in the net assets of the enterprise. assets of the enterprise. (j) (j) Increases assets through Increases assets through sale of product. sale of product. (k) (k) Decreases assets by Decreases assets by purchasing the company’s purchasing the company’s own stock. own stock. (l) (l) Changes in equity during Changes in equity during the period, except those the period, except those from investments by from investments by owners and distributions to owners and distributions to owners. owners. LO 5 Define the basic elements of financial statements. LO 5 Define the basic elements of financial statements. (a) Elements (b) (d) (c) (a) (f) (e) (h) (c) (h) (i) (j) (k) (l)
  • 28. Chapter 2-28 Review: Review: Second Level: Elements Second Level: Elements According to the FASB conceptual framework, an According to the FASB conceptual framework, an entity’s revenue may result from entity’s revenue may result from a. a. A decrease in an asset from primary operations. A decrease in an asset from primary operations. b. b. An increase in an asset from incidental An increase in an asset from incidental transactions. transactions. c. c. An increase in a liability from incidental An increase in a liability from incidental transactions. transactions. d. d. A decrease in a liability from primary operations. A decrease in a liability from primary operations. LO 5 Define the basic elements of financial statements. LO 5 Define the basic elements of financial statements. (CPA adapted) (CPA adapted)
  • 29. Chapter 2-29 Third Level: Recognition and Measurement Third Level: Recognition and Measurement The FASB sets forth most of these concepts in its Statement of Financial Accounting Concepts No. 5, “Recognition and Measurement in Financial Statements of Business Enterprises.” ASSUMPTIONS ASSUMPTIONS 1. 1. Economic entity Economic entity 2. 2. Going concern Going concern 3. 3. Monetary unit Monetary unit 4. 4. Periodicity Periodicity PRINCIPLES PRINCIPLES 1. 1. Historical cost Historical cost 2. 2. Revenue recognition Revenue recognition 3. 3. Matching Matching 4. 4. Full disclosure Full disclosure CONSTRAINTS CONSTRAINTS 1. 1. Cost-benefit Cost-benefit 2. 2. Materiality Materiality 3. 3. Industry practice Industry practice 4. 4. Conservatism Conservatism LO 6 Describe the basic assumptions of accounting. LO 6 Describe the basic assumptions of accounting.
  • 30. Chapter 2-30 Economic Entity – company keeps its activity separate 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 Third Level: Assumptions LO 6 Describe the basic assumptions of accounting. LO 6 Describe the basic assumptions of accounting.
  • 31. Chapter 2-31 Third Level: Assumptions Third Level: Assumptions LO 6 Describe the basic assumptions of accounting. LO 6 Describe the basic assumptions of accounting. Brief Exercise 2-4 Identify which basic assumption of accounting is best described in each item below. (a) The economic activities of FedEx Corporation are divided into 12-month periods for the purpose of issuing annual reports. (b) Solectron Corporation, Inc. does not adjust amounts in its financial statements for the effects 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 for accounting and reporting purposes. Periodicity Periodicity Going Concern Going Concern Monetary Monetary Unit Unit Economic Economic Entity Entity
  • 32. Chapter 2-32 Historical Cost – the price, established by the exchange transaction, is the “cost”. Issues: Historical cost provides a reliable benchmark for measuring 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 Third Level: Principles LO 7 Explain the application of the basic principles of accounting. LO 7 Explain the application of the basic principles of accounting.
  • 33. Chapter 2-33 Revenue Recognition - generally occurs (1) when realized or realizable and (2) when earned. Exceptions: During Production. At End of Production Upon Receipt of Cash Third Level: Principles Third Level: Principles LO 7 Explain the application of the basic principles of accounting. LO 7 Explain the application of the basic principles of accounting.
  • 34. Chapter 2-34 Matching - efforts (expenses) should be matched with accomplishment (revenues) whenever it is reasonable and practicable to do so. “Let the expense follow the revenues.” Third Level: Principles Third Level: Principles LO 7 Explain the application of the basic principles of accounting. LO 7 Explain the application of the basic principles of accounting. Illustration 2-4 Illustration 2-4 Expense Recognition
  • 35. Chapter 2-35 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 Third Level: Principles Third Level: Principles LO 7 Explain the application of the basic principles of accounting. LO 7 Explain the application of the basic principles of accounting.
  • 36. Chapter 2-36 Third Level: Principles Third Level: Principles LO 7 Explain the application of the basic principles of accounting. LO 7 Explain the application of the basic principles of accounting. Brief Exercise 2-5 Identify which basic principle of accounting is best described in each item below. (a) Norfolk Southern Corporation reports revenue in its income statement when it is earned instead of when the cash is collected. (b) Yahoo, Inc. recognizes depreciation expense for a machine over the 2-year period during which that machine helps the company earn revenue. (c) Oracle Corporation reports information about pending lawsuits in the notes to its financial statements. (d) Eastman Kodak Company reports land on its balance sheet at the amount paid to acquire it, even though the estimated fair market value is greater. Revenue Revenue Recognition Recognition Matching Matching Full Full Disclosure Disclosure Historical Historical Cost Cost
  • 37. Chapter 2-37 Cost Benefit – 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. Industry Practice - the peculiar nature of some industries and business concerns sometimes requires departure from basic accounting theory. Conservatism – when in doubt, choose the solution that will be least likely to overstate assets and income. Third Level: Constraints Third Level: Constraints LO 8 Describe the impact that constraints have LO 8 Describe the impact that constraints have on reporting accounting information. on reporting accounting information.
  • 38. Chapter 2-38 Brief Exercise 2-6 What accounting constraints are illustrated by the items below? (a) Zip’s Farms, Inc. reports agricultural crops on its balance sheet at market value. (b) Crimson Tide Corporation does not accrue a contingent lawsuit gain of $650,000. (c) Wildcat Company does not disclose any information in the notes to the financial statements unless the value of the information to users exceeds the expense of gathering it. (d) Sun Devil Corporation expenses the cost of wastebaskets in the year they are acquired. Industry Industry Practice Practice Conservatism Conservatism Third Level: Constraints Third Level: Constraints Cost-Benefit Cost-Benefit Materiality Materiality LO 8 Describe the impact that constraints have LO 8 Describe the impact that constraints have on reporting accounting information. on reporting accounting information.
  • 39. Chapter 2-39 Copyright © 2006 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein. Copyright Copyright

Editor's Notes

  • #2: 1. On the topic, “Challenges Facing Financial Accounting,” what did the AICPA Special Committee on Financial Reporting suggest should be included in future financial statements? Non-financial Measurements (customer satisfaction indexes, backlog information, and reject rates on goods purchases). Forward-looking Information Soft Assets (a company’s know-how, market dominance, marketing setup, well-trained employees, and brand image). Timeliness (no real time financial information)
  • #3: Service Cost - Actuaries compute service cost as the present value of the new benefits earned by employees during the year. Future salary levels considered in calculation. Interest on Liability - Interest accrues each year on the PBO just as it does on any discounted debt. Actual Return on Plan Assets - Increase in pension funds from interest, dividends, and realized and unrealized changes in the fair market value of the plan assets. Amortization of Unrecognized Prior Service Cost - The cost of providing retroactive benefits is allocated to pension expense in the future, specifically to the remaining service-years of the affected employees. Gain or Loss - Volatility in pension expense can be caused by sudden and large changes in the market value of plan assets and by changes in the projected benefit obligation. Two items comprise the gain or loss: difference between the actual return and the expected return on plan assets and, amortization of the unrecognized net gain or loss from previous periods
  • #5: Technical Bulletins provide answers to specific questions related to the application and implementation of FASB Statement or Interpretations, APB Opinions, and ARBs. Technical Bulletins do not alter GAAP; they merely provide guidance on questions related to existing GAAP.
  • #6: Technical Bulletins provide answers to specific questions related to the application and implementation of FASB Statement or Interpretations, APB Opinions, and ARBs. Technical Bulletins do not alter GAAP; they merely provide guidance on questions related to existing GAAP.