Chapter

2-1
 CHAPTER 2
CONCEPTUAL FRAMEWORK
UNDERLYING FINANCIAL
ACCOUNTING

Intermediate Accounting
13th Edition
Kieso, Weygandt, and
Warfield
Chapter
2-2
 Learning
Learning Objectives
Objectives
1. Describe the usefulness of a conceptual framework.
2. Describe the FASB’s efforts to construct a conceptual
framework.
3. Understand the objectives of financial reporting.
4. Identify the qualitative characteristics of accounting
information.
5. Define the basic elements of financial statements.
6. Describe the basic assumptions of accounting.
7. Explain the application of the basic principles of
accounting.
8. Describe the impact that constraints have on
reporting accounting information.

Chapter
2-3
 Financial
Financial Accounting
Accounting and
and Accounting
Accounting
Standards
Standards

Second Level: Third Level:

Conceptual First Level: Basic
Fundamental Recognition and
Framework Objectives
Concepts Measurement

Need Decision Qualitative Basic assumptions

Development usefulness characteristics Basic principles
Information about Basic elements Constraints
economic
resources

Chapter
2-4
 Conceptual
Conceptual Framework
Framework

The Need for a Conceptual Framework

To develop a coherent set of standards and
rules
To solve new and emerging practical
problems

Chapter
2-5 LO 1 Describe the usefulness of a conceptual framework.
 Conceptual
Conceptual Framework
Framework

Review:
A conceptual framework underlying financial
accounting is important because it can lead
to consistent standards and it prescribes the
nature, function, and limits of financial
accounting and financial statements.

True

Chapter
2-6 LO 1 Describe the usefulness of a conceptual framework.
 Conceptual
Conceptual Framework
Framework

Review:
A conceptual framework underlying
financial accounting is necessary because
future accounting practice problems can
be solved by reference to the conceptual
framework and a formal standard-setting
body will not be necessary.
False

Chapter
2-7 LO 1 Describe the usefulness of a conceptual framework.
 Development
Development of
of Conceptual
Conceptual
Framework
Framework
The FASB has issued six Statements of Financial
Accounting Concepts (SFAC) for business
enterprises.
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Statements (superceded by SFAC No. 6)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.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
Chapter
2-8 LOAccounting
2 DescribeMeasurements Objective 2
the FASB’s efforts to construct a conceptual
 Conceptual
Conceptual Framework
Framework

The Framework is comprised of three

levels:
First Level = Basic Objectives
Second Level = Qualitative Characteristics
and Basic Elements
Third Level = Recognition and Measurement
Concepts.

The FASB and the IASB have agreed on a joint project to

develop a common and improved conceptual framework.

Chapter
2-9 LO 2 Describe the FASB’s efforts to construct a conceptual
 ASSUMPTIONS PRINCIPLES CONSTRAINTS
1. Economic entity 1. Measurement 1. Cost-benefit
2. Going concern 2. Revenue recognition 2. Materiality Third
3. Monetary unit 3. Expense recognition 3. Industry practice level
4. Periodicity 4. Full disclosure 4. Conservatism

QUALITATIVE
CHARACTERISTICS ELEMENTS
Relevance Assets, Liabilities, and Equity
Investments by owners
Reliability Distribution to owners Second level
Comparability Comprehensive income
Revenues and Expenses
Consistency Gains and Losses
Illustration 2-7
Conceptual
Framework for OBJECTIVES
Financial Reporting 1. Useful in investment
and credit decisions
2. Useful in assessing
future cash flows First level
3. About enterprise
resources, claims to
resources, and
changes in them LO 2 Describe the FASB’s
Chapter efforts to construct a
2-10 conceptual framework.
 Conceptual
Conceptual Framework
Framework
Review:
What are the Statements of Financial Accounting
Concepts 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
developing standards of financial accounting
and reporting.
d. The hierarchy of sources of generally accepted
accounting principles. (CPA adapted)
Chapter
2-11 LO 2 Describe the FASB’s efforts to construct a conceptual
 First
First Level:
Level: Basic
Basic Objectives
Objectives

Financial
Financial reporting
reporting should
should provide
provide information
information that:
that:
(a)
(a) is
is useful
useful to
to present
present and
and potential
potential investors
investors and
and creditors
creditors
and
and other
other users
users in
in making
making rational
rational investment,
investment, credit,
credit,
and
and similar
similar decisions.
decisions.
(b)
(b) helps
helps present
present and
and potential
potential investors
investors and
and creditors
creditors and
and
other
other users
users in
in assessing
assessing the
the amounts,
amounts, timing,
timing, and
and
uncertainty
uncertainty ofof prospective
prospective cash
cash receipts.
receipts.
(c)
(c) portrays
portrays the
the economic
economic resources
resources of of an
an enterprise,
enterprise, the
the
claims
claims to
to those
those resources,
resources, andand the
the effects
effects of
of
transactions,
transactions, events,
events, and
and circumstances
circumstances that
that change
change its
its
resources
resources andand claims
claims to
to those
those resources.
resources.

Chapter
2-12 LO 3 Understand the objectives of financial
 First
First Level:
Level: Basic
Basic Objectives
Objectives

Review:
According to the FASB conceptual framework, the
objectives of financial reporting for business
enterprises are based on?
a. Generally accepted accounting principles
b. Reporting on management’s stewardship.
c. The need for conservatism.
d. The needs of the users of the information.

The current proposed converged framework adopts the

FASB’s focus on investors and creditors.
Chapter
2-13 LO 3
 Second
Second Level:
Level: Fundamental
Fundamental
Concepts
Concepts
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?
Answer:
By determining which alternative provides the
most useful information for decision-making
purposes (decision usefulness).

Chapter
2-14 LO 4 Identify the qualitative characteristics of accounting
 Second
Second Level:
Level: Fundamental
Fundamental
Concepts
Concepts
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.”

Chapter
2-15 LO 4 Identify the qualitative characteristics of accounting
 Second
Second Level:
Level: Qualitative
Qualitative
Characteristics
Characteristics

Illustration 2-2
Hierarchy of Accounting
Qualities

Chapter
2-16 LO 4 Identify the qualitative characteristics of accounting
 Second
Second Level:
Level: Fundamental
Fundamental
Concepts
Concepts
Understandability
A company may present highly relevant and
reliable information, however it was useless to
those who do not understand it.

Chapter
2-17 LO 4 Identify the qualitative characteristics of accounting
 ASSUMPTIONS PRINCIPLES CONSTRAINTS
1. Economic entity 1. Measurement 1. Cost-benefit
2. Going concern 2. Revenue recognition 2. Materiality Third
Relevance
Relevance and
3. Monetary unitand
3. Expense Reliability
Reliability
recognition 3. Industry practice level
4. Periodicity 4. Full disclosure 4. Conservatism

QUALITATIVE
CHARACTERISTICS ELEMENTS
Relevance Assets, Liabilities, and Equity
Investments by owners
Reliability Distribution to owners Second level
Comparability Comprehensive income
Revenues and Expenses
Consistency Gains and Losses
Illustration 2-7
Conceptual
Framework for OBJECTIVES
Financial Reporting 1. Useful in investment
and credit decisions
2. Useful in assessing
future cash flows First level
3. About enterprise
resources, claims to
resources, and
changes in them LO 4 Identify the
Chapter qualitative
2-18 characteristics of
 Second
Second Level:
Level: Qualitative
Qualitative
Characteristics
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

In the proposed converged conceptual framework, reliability will be

replaced with “faithful representation” as one of the primary qualitative
Chapter characteristics that must be present for information to be useful.
2-19 LO 4
 Second
Second Level:
Level: Qualitative
Qualitative
Characteristics
Characteristics
Review:
Relevance and reliability are the two primary
qualities that make accounting information
useful for decision making.

True
To be reliable, accounting information must be
capable of making a difference in a decision.

False
Chapter
2-20 LO 4 Identify the qualitative characteristics of accounting
 ASSUMPTIONS PRINCIPLES CONSTRAINTS
1. Economic entity 1. Measurement 1. Cost-benefit
2. Going concern 2. Revenue recognition 2. Materiality Third
Comparability
Comparability
3. Monetary unit and
and
3. Expense Consistency
Consistency
recognition 3. Industry practice level
4. Periodicity 4. Full disclosure 4. Conservatism

QUALITATIVE
CHARACTERISTICS ELEMENTS
Relevance Assets, Liabilities, and Equity
Investments by owners
Reliability Distribution to owners Second level
Comparability Comprehensive income
Revenues and Expenses
Consistency Gains and Losses
Illustration 2-7
Conceptual
Framework for OBJECTIVES
Financial Reporting 1. Useful in investment
and credit decisions
2. Useful in assessing
future cash flows First level
3. About enterprise
resources, claims to
resources, and
changes in them LO 4 Identify the
Chapter qualitative
2-21 characteristics of
 Second
Second Level:
Level: Qualitative
Qualitative
Characteristics
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 LO 4 Identify the qualitative characteristics of accounting
 Second
Second Level:
Level: Qualitative
Qualitative
Characteristics
Characteristics
Review:
Adherence to the concept of consistency
requires that the same accounting principles
be applied to similar transactions for a
minimum of five years before any change in
principle is adopted.
False

Chapter
2-23 LO 4 Identify the qualitative characteristics of accounting
 ASSUMPTIONS PRINCIPLES CONSTRAINTS
1. Economic entity 1. Measurement 1. Cost-benefit
2. Going concern 2. Revenue recognition 2. Materiality Third
3. Monetary unit Basic
Basic Elements
Elements
3. Expense recognition 3. Industry practice level
4. Periodicity 4. Full disclosure 4. Conservatism

QUALITATIVE
CHARACTERISTICS ELEMENTS
Relevance Assets, Liabilities, and Equity
Investments by owners
Reliability Distribution to owners Second level
Comparability Comprehensive income
Revenues and Expenses
Consistency Gains and Losses
Illustration 2-7
Conceptual
Framework for OBJECTIVES
Financial Reporting 1. Useful in investment
and credit decisions
2. Useful in assessing
future cash flows First level
3. About enterprise
resources, claims to
resources, and
changes in them LO 5 Define the basic
Chapter elements of
2-24 financial
 Second
Second Level:
Level: Basic
Basic Elements
Elements
Concepts Statement No. 6 defines ten
interrelated elements that relate to measuring the
performance and financial status of a business
enterprise.
“Moment in Time” “Period of Time”
Assets Investment by
Liabilities owners
Equity Distribution to
owners
Comprehensive
income
Revenue
Expenses
Chapter
2-25 LO 5 Gains
Define the basic elements of financial
 Second
Second Level:
Level: Basic
Basic Elements
Elements
Exercise 2-3: Identify the element or elements
associated with items below. Elements
(a) Arises from peripheral or Assets
incidental transactions. (b) Liabilities
(b) Obligation to transfer
Equity
resources arising from a
(c) Investment by
past transaction.
(d) owners
(c) Increases ownership
interest. (e) (c) Distribution to
(d) Declares and pays cash owners
dividends to owners. Comprehensive
(e) Increases in net assets in income
(a)
a period from nonowner Revenue
Chapter sources. (a)
2-26 Expenses LO 5
 Second
Second Level:
Level: Basic
Basic Elements
Elements
Exercise 2-3: Identify the element or elements
associated with items below. Elements
(f) Assets
(f) Items characterized by
future economic benefit. (b) Liabilities
(g) Equals increase in net Equity
assets during the year, (c) Investment by
after adding distributions
(d) owners
to owners and
subtracting investments (g) (e) (c) Distribution to
by owners. (h) owners
(h) Arises from income (h) Comprehensive
statement activities that income
(a)
constitute the entity’s Revenue
Chapter ongoing major or central (a)
2-27 Expenses LO 5
operations.
 Second
Second Level:
Level: Basic
Basic Elements
Elements
Exercise 2-3: Identify the element or elements
associated with items below. Elements
(i) Residual interest in the (f) Assets
net assets of the (b) Liabilities
enterprise.
(i) Equity
(j) Increases assets through
(c) Investment by
sale of product.
(k) (d) owners
(k) Decreases assets by
purchasing the (l) (g) (e) (c) Distribution to
company’s own stock. (j) (h) owners
(l) Changes in equity during (h) Comprehensive
the period, except those income
(a)
from investments by
Revenue
Chapter owners and distributions (a)
2-28
to owners. Expenses LO 5
 Second
Second Level:
Level: Basic
Basic Elements
Elements
Review:
According to the FASB conceptual framework, an
entity’s revenue may result from
a. A decrease in an asset from primary operations.
b. An increase in an asset from incidental
transactions.
c. An increase in a liability from incidental
transactions.
d. A decrease in a liability from primary operations.

(CPA adapted)
Chapter
2-29 LO 5 Define the basic elements of financial
 Third
Third Level:
Level: Recognition
Recognition and and
Measurement
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 PRINCIPLES CONSTRAINTS

1. Economic entity 1. Measurement 1. Cost-benefit
2. Going concern 2. Revenue recognition 2. Materiality
3. Monetary unit 3. Expense recognition 3. Industry practice
4. Periodicity 4. Full disclosure 4. Conservatism

Chapter
2-30 LO 6 Describe the basic assumptions of accounting.
 Third
Third Level:
Level: Assumptions
Assumptions

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.

Chapter
2-31 LO 6 Describe the basic assumptions of accounting.
 Third
Third Level:
Level: Assumptions
Assumptions
Brief Exercise 2-4: Identify which basic assumption of
accounting is best described in each item below.
(a) The economic activities of KC Corporation
are divided into 12-month periods for the Periodicity
purpose of issuing annual reports.
(b) Solectron Corporation, Inc. does not adjust
Monetary
amounts in its financial statements for the
Unit
effects of inflation.
(c) Walgreen Co. reports current and
noncurrent classifications in its balance
Going Concern
sheet.
(d) The economic activities of General Electric Economic
and its subsidiaries are merged for Entity
Chapter
accounting and reporting purposes.
2-32 LO 6 Describe the basic assumptions of accounting.
 Third
Third Level:
Level: Principles
Principles

Measurement – The most commonly used

measurements are based on historical cost and
fair value.
Issues:
Historical cost provides a reliable benchmark for
measuring historical trends.
Fair value information may be more useful.
Recently the FASB has taken the step of giving
companies the option to use fair value as the basis
for measurement of financial assets and financial
liabilities.
Chapter
2-33 Reporting
LOof
7 fair value
Explain information
the application is increasing.
of the basic principles of
 Third
Third Level:
Level: Principles
Principles

Revenue Recognition - generally occurs (1)

when realized or realizable and (2) when earned.
Exceptions: Illustration 2-4
Timing of Revenue
Recognition

Chapter
2-34 LO 7 Explain the application of the basic principles of
 Third
Third Level:
Level: Principles
Principles

Expense Recognition - “Let the expense

follow the revenues.”
Illustration 2-5
Expense
Recognition

Chapter
2-35 LO 7 Explain the application of the basic principles of
 Third
Third Level:
Level: Principles
Principles

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

Chapter
2-36 LO 7 Explain the application of the basic principles of
 Third
Third Level:
Level: Principles
Principles
Brief Exercise 2-5: Identify which basic principle
of accounting is best described in each item below.
(a) KC Corporation reports revenue in its income Revenue
statement when it is earned instead of when the Recognitio
cash is collected. n
(b) Yahoo, Inc. recognizes depreciation expense Expense
for a machine over the 2-year period during Recognitio
which that machine helps the company earn n
revenue.
(c) Oracle Corporation reports information about
Full
pending lawsuits in the notes to its financial Disclosure
statements.
(d) Eastman Kodak Company reports land on its Measurement
balance sheet at the amount paid to acquire it,
even though the LO
Chapter
2-37
estimated fair
7 Explain themarket value
application of is
the basic principles of
greater.
 Third
Third Level:
Level: Constraints
Constraints
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
Chapter
2-38 assets and [Link] 8 Describe the impact that constraints
have on reporting accounting
 Third
Third Level:
Level: Constraints
Constraints
Brief Exercise 2-7: What accounting constraints
are illustrated by the items below?
(a) KC, Inc. reports agricultural crops on its Industry
balance sheet at market value. Practice
(b) Rafael Corporation does not accrue a
contingent lawsuit gain of $650,000. Conservatism

(c) Willis Company does not disclose any

information in the notes to the financial Cost-
statements unless the value of the Benefit
information to users exceeds the
expense of gathering it.
Materiality
(d) Favre Corporation expenses the cost of
wastebaskets in the year they are
Chapter
2-39 acquired. LO 8
  The existing conceptual frameworks underlying U.S. GAAP and
iGAAP are very similar.
 The converged framework should be a single document, unlike
the two conceptual frameworks that presently exist.
 The IASB framework makes two assumptions. One assumption
is that financial statements are prepared on an accrual basis;
the other is that the reporting entity is a going concern.
 There is some agreement that the role of financial reporting is
to assist users in decision making. However, others note that
another objective is to provide information on management’s
Chapter performance, often referred to as stewardship.
2-40
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Chapter
2-41