Question

A sound foundation is necessary for success in any task from building a house to putting on makeup. In terms of U.S. Accounting Standards, it is also necessary to have a sound foundation, referred to as the conceptual framework. Let's discuss the conceptual framework. Which of the conceptual framework components do you feel is most important? Why? Be sure to support your answer from the readings in the course.

Answer 1

Conceptual Framework

A conceptual framework can be defined as a system of ideas and objectives that lead to the creation of a consistent set of rules and standards. Specifically in accounting, the rule and standards set the the nature, function and limits of financial accounting and financial statements.

The main reasons for developing an agreed conceptual framework are that it provides:

• a framework for setting accounting standards;
• a basis for resolving accounting disputes;
• fundamental principles which then do not have to be repeated in accounting standards.

The main reasons for developing an agreed conceptual framework are that it provides a framework for setting accounting standards, a basis for resolving accounting disputes, fundamental principles which then do not have to be repeated in accounting standards.The Financial Accounting Standards Board ( FASB ) is a private, not-for-profit organization whose mission is “to establish and improve standards of financial accounting and reporting for the guidance and education of the public, including issuers, auditors, and users of financial information.Created in 1973, FASB replaced the Committee on Accounting Procedure (CAP) and the Accounting Principles Board (APB) of the American Institute of Certified Public Accountants (AICPA).FASB’s Conceptual Framework, a project begun in 1973 to develop a sound theoretical basis for the development of accounting standards in the United States. From 1978 to 2010 the FASB released eight concept statements.

FASB’s Conceptual Framework, a project begun in 1973 to develop a sound theoretical basis for the development of accounting standards in the United States. From 1978 to 2010 the FASB released eight concept statements.

1. OBJECTIVES OF FINANCIAL REPORTING BY BUSINESS ENTERPRISES (SFAC No. 1) 1978
2. QUALITATIVE CHARACTERISTICS OF ACCOUNTING INFORMATION (SFAC No. 2)1980
3. ELEMENTS OF FINANCIAL STATEMENTS OF BUSINESS ENTERPRISES (SFAC No. 3)1980
4. OBJECTIVES OF FINANCIAL REPORTING BY NONBUSINESS ORGANIZATIONS (SFAC No. 4) 1980
5. RECOGNITION AND MEASUREMENT IN FINANCIAL STATEMENTS OF BUSINESS ENTERPRISES (SFAC No. 5)1984
6. ELEMENTS OF FINANCIAL STATEMENTS; a replacement of FASB Concepts Statement N. 3, also incorporating an amendment of FASB Concepts Statement No. 2 (SFAC N. 6) 1985
7. USING CASH FLOW INFORMATION AND PRESENT VALUE IN ACCOUNTING MEASUREMENTS (SFAC No. 7) 2000
8. No. 8. CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING, a replacement of SFAC No. 1 and No. 2 2010

Importance of Conceptual Framework

With a sound conceptual framework in place the FASB is able to issue consistent and useful standards. In addition, without an existing set of standards, it isn’t possible to resolve any new problems that emerge.

The framework also increases financial statement users’ understanding of and confidence in financial reporting and makes it easier to compare different companies’ financial statements.

Developing FASB’s Conceptual Framework: 4 Components:The following points highlight the four major components of Financial Accounting Standards Board (FASB) in developing conceptual framework.

The components are:

1. The Objectives of Financial Reporting

2. The Qualities of Useful Information

3. Elements of Financial Statements

4. Recognition and Measurement.

1. The Objectives of Financial Reporting:

The FASB’s first Statement of Financial Accounting Concepts (SFAC 1) (1978) identified the broad objectives of financial reporting. The first and most general objective stated in SFAC 1 is to “provide information that is useful to present and potential investors and creditors and other users in making rational investment, credit, and similar decisions.”From this beginning point in SFAC 1, the Board expressed other more specific objectives.

These objectives recognize:

(i) That financial reporting should help users predict future cash flows, and

(ii) That information about a company’s resources and obligations is useful in making such predictions.

All the concepts in the conceptual framework are intended to be consistent with these general objectives. In USA, present accounting practice already provides information about a company’s resources and obligations. Thus, although the conceptual framework is intended to be prescriptive of new and improved practices, the concepts in the framework are also descriptive of many current practices.

2. The Qualities of Useful Information:

The next component in the conceptual framework is the qualities (or qualitative characteristics) that financial information should have if it is to be useful in decision making. In SFAC 2, the FASB said that information is useful if it is (i) relevant, (ii) reliable, and (iii) comparable. Information is relevant if it can make difference in a decision. Information has this quality when it helps users predict the future or evaluate the past and is received in time to affect their decisions.

Information is reliable if users can depend on it to be free from bias and error. Reliable information is verifiable-and faithfully represents what is supposed to be described. In addition, users can depend on information only if it is neutral. This means that the rules used to produce information should not be designed to lead users to accept or reject any specific decision alternative.

Information is comparable if users can use it to identify differences and similarities between companies. Comparability is possible only if companies follow uniform practices. However, even if all companies uniformly follow the same practices, comparable reports do not result if the practices are not appropriate. For example, comparable information would not be provided if all companies were to ignore the useful lives of their assets and depreciate all assets over two years.

Comparability also requires consistency, which means that a company should not change its accounting practices unless the change is justified as a reporting improvement. Another important concept discussed in SFAC 2 is materiality.

3. Elements of Financial Statements:

Another important step in developing a conceptual framework is to determine the elements of financial statements. This involves defining the categories of information that should be contained in financial reports. The FASB’s discussion of financial statement elements includes definitions of important elements such as assets, liabilities, equity, revenues, expenses, gains, and losses.

The FASB’s pronouncement on financial statement elements was first published in 1980 as SFAC 3. In 1985, SFAC 3 was replaced by SFAC 6, which modified the discussion of financial statement elements to include several elements for not for-profit accounting entities.

4. Recognition and Measurement:

In SFAC 5, “Recognition and Measurement in Financial Statements of Business Enterprises,” the FASB established concepts for deciding (1) when items should be presented (or recognized) in the financial statements, and (2) how to assign numbers to (or measure) those items.

In general, the FASB has said that items should be recognized in the financial statements if  they meet the following criteria:

(i) Definitions — the item meets the definition of an element of financial statements;

(ii) Measurability — it has a relevant attribute measurable with sufficient reliability;

(iii) Relevance — the information about it is capable of making a difference in user decisions; and

(iv) Reliability— the information is representationally faithful, verifiable, and neutral.

In SFAC 5, the FASB has stated that a full set of financial statements should show:

(i) Financial position at the end of the period.

(ii) Earnings for the period.

(iii) Comprehensive income for the period. (This new concept is broader than earnings and includes all changes in owners’ equity other than those that resulted from transactions with the owners. Some changes in asset values are included in this concept but are excluded from earnings).

(iv) Cash flows during the period.

(v) Investments by and distributions to owners during the period.

Fan's conceptual framework components is the important that I realize through above descriptions.