Chapter 2 Conceptual Frameworks. Provide the structure for building a set of coherent accounting standards. Levels: “Why” - Provides objectives of financial reporting
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Provide information that is useful to those making investment & credit decisions.
Helpful to present and potential investors, creditor and other users in assessing the amounts, timing and uncertainty of future cash flows; and
About economic resources, the claims to those resources and the changes in them.
Per IASB Framework (April 1989)
The objective of f/s’s is to provide information about the financial position, performance and changes in financial position of an entity that is useful to a wide range of users in making economic decisions.
Users are present & potential investors, employees, lenders, suppliers & other trade creditors, customers, gov’ts & their agencies & the general public.Level 1: Objectives of Financial Reporting
Substance over form
ComparabilityLevel 2: Qualitative Characteristics
DR R&D Asset?
For each alternative consider:
What is the relevance/reliability tradeoff?
How can the treatment be theoretically supported?
Does US or IFRS allow?Relevance and Reliability – Tradeoff Example
Draft f/s for 2004 show net income of $1.5 million dollars
However, the CFO argues that slowing sales indicate that inventory may be overvalued, and advocates the following journal entry:
Dr. Cost of Goods Sold (overvalued goods) 400,000
Cr. Inventory 400,000
What would this entry do? Cause COGS to be 400K lower in following year
Sometimes this practice is called the “cookie jar”
What if projected net income in 2005 was $800,000 (before this journal entry was made)?How to Cheat with Conservatism
(a) Arises from peripheral or incidental transactions.
(b) Obligation to transfer resources arising from a past transaction.
(c) Increases ownership interest.
(d) Declares and pays cash dividends to owners.
(e) Increases in net assets in a period from nonowner sources.
(f) Items characterized by future economic benefit.
(g) Equals increase in net assets during the year, after adding distributions to owners and subtracting investments by owners.
(h) Arises from income statement activities that constitute the entity’s ongoing major or central operations.
(i) Residual interest in the net assets of the enterprise.
(j) Increases assets through sale of product.
(k) Decreases assets by purchasing the company’s own stock.
Full disclosureLevel 3: Basic Assumptions, Principles
If a firm bought land in 1950 for $10K and still owned it in 2009, would it appear on the 2009 financial statements at $10K even if it is now worth $1 million?
How is your answer justified by the conceptual framework?Level 3: Principles
Earned – seller substantially completed what it must do to be entitled to keep resources received from the transaction.
Realized or realizable –buyer provided resources or resources to be received are readily convertible to some other asset.
Revenue is generally at the point of sale. Exceptions:
During production – long term construction contracts (% Completion Method)
(2) End of production – when ready market at quoted price exists (mining and agriculture)
(3) Upon receipt of cash – when collections uncertain at time of sale (Installment sales method)Level 3: Principles
Notes to financial statements
Supplementary informationLevel 3: Principles
“Study Pursuant to Section 108(d) of the Sarbanes-Oxley Act of 2002 on…Principles-Based Accounting System”
Kapnick (1974) and Wyatt (2004)
What is meant by principles vs. rules based accounting?
Why did Congress want this examined?
What are the benefits and concerns with principles based accounting?
Are judgment and professional ethics more or less important under principles based accounting?Professional Ethics and Principles Based Accounting