Conceptual Framework

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FASB's Conceptual Framework
- sets forth underlying principles of fin'l actg
- FASB and IASB have a joint project to improve and converge their fin'l reporting frameworks
- as phases of FASB/IASB's joint project are completed, FASB will issue each component of the conceptual f/w as a chapter in Statement No. 8
Statements of Fin'l Actg Concepts (SFAC)
- NOT GAAP, thus NOT authoritative
- provides a basis for financial accounting concepts for business and nonbusiness enterprises
SFAC No. 8 [title]
"Conceptual Framework for Financial Reporting"
SFAC No. 8 - Chapter 1
"The Objective of General Purpose Financial Reporting"
- objective of general purpose fin'l reporting: to provide fin'l info about reporting entity that's useful to primary USERS of general purpose fin'l reports in making decisions about providing resources to that entity
SFAC No. 8 - Chapter 3
"Qualitative Characteristics of Useful Information"
- Discusses:
1) Fundamental Qualitative Characteristics
2) Enhancing Qualitative Characteristics
3) Cost Constraint
1) Fundamental Qualitative Characteristics
a) Relevance: capable of making a difference in dec made by user; to be relevant, must have:
b) Faithful Representation: reported info must faithfully represent reported economic phenomena
- Note: perfect faith. rep. generally not achievable

c) This Chapter also includes Steps to apply [it]
a) Relevance criteria
i) Predictive Value: can be used to predict future outcomes
ii) Confirming Value: provides feedback about evaluations previously made by users
iii) Materiality: info is material if omission/misstatement could affect user's decision; materiality is entity-specific
b) Faithful Representation criteria
i) Completeness: fin'l info should include all info necessary for user to understand the reported eco'ic phenomena
- include descriptions and explanations
ii) Neutrality: neutral depiction of fin'l info is free from bias in selection and presentation
iii) Freedom from Error: no errors in selection or application of the process used to produce reported fin'l info and there are no errors or omissions in the descriptions of eco'ic phenomena.
- Does not require perfect accuracy (e.g. cuz hard to determine perfect accur of estimates)
c) Steps to Apply the Fundamental Qualitative Characteristics
i) ID the phenomena that has the potential to be useful to users
ii) ID the type of info about the phenomena that would be most relevant
iii) Determine whether the info is available and can be faithfully represented
2) Enhancing Qualitative Characteristics
[think VCUT]
a) Comparability
b) Verifiability
c) Timeliness
d) Understandability
a) Comparability
- info is more useful if it can be compared with similar info about other entities or from other time periods;
- [it] enables users to ID similarities and differences among items
- consistency (use of same methods) helps to achieve [it]
b) Verifiability
- different knowledgeable and independent observers can reach consensus that a particular depiction is faithfully represented
- [it] does not require complete agreement
c) Timeliness
the info is available to users in time to be capable of influencing their decisions
d) Understandability
- info sb classified, characterized, and presented clearly and concisely
- users may need assistance of experts with complex and difficult phenomena
3) Cost Constraint
- [it] is a pervasive limitation on the info provided in fin'l reporting
- benefits must > cost of obtaining and presenting info
- FASB/IASB consider cost/benefit in relation to fin'l reporting in general and NOT at the individual reporting entity level
SFAC No. 4, Obj of Fin'l Reporting by Nonbusiness Org
consists of/outlines:
1) char'ics that distinguish bus from nonbus org's
2) users of fin'l reports of nonbus org's
3) obj of fin'l reporting of nonbus org's
1) Char'ics of nonbus org's
a) significant portion of their resources from contributions and grants
b) operating purposes are other than to provide G/S for profit
c) lack ownership interests that can be sold, transferred, or redeemed, or that allow claim on resources upon liquidation
2) users of fin'l info of nonbus org's
a) resource providers (lender, suppliers, employers, members, contributors, taxpayers)
b) constituents who use and benefit from the services provided by nonbus org
c) governing and oversight bodies who are responsible for setting policies and for overseeing and evaluating managers of nonbus org's
d) mngers who are responsible for carrying out the policy mandates of the governing bodies and managing the day-to-day operations of the org
3) objectives of fin'l reporting of nonbus org's
a) info useful in making resource allocation decisions
b) info useful in assessing its services and the ability to provide services
c) info useful in assessing mgt stewardship and performance
d) info about eco'ic resources, obligations, and net resources, organization performance, the nature of and relationship btn inflows and outflows, service efforts and accomplishments, and liquidity
SFAC No. 5, "Recognition and Measurement in F/S"
Sets forth recognition criteria and guidance on whatwhen info sb incorporated in F/S; it addresses:
1) Full set of F/S
2) Fundamental Recognition Criteria
3) Measurement Attributes for Assets and Liab's
4) Fundamental Assumptions
1) Full set of F/S
a) St of Fin'l Position (B/S)
b) St of earnings (inc st)
c) St of Comprehensive Income
d) St of CF
e) St of changes in owner's equity (R/E)
2) Fundamental Recognition Criteria
Recognition is the process of formally recording/incorporating an item in the F/S and classifying it as an A, L, E, rev, or exp
a) definitions
b) measurability
c) relevance
d) reliability
3) Measurement Attributes for A and L
[valuation methods]
a) HC (e.g. PPE)
b) Current Cost (Inventory)
c) NRV (A/R)
d) Current market value (marketable sec)
e) PV of future CF (L-T Debt like bonds)
4) Fundamental Assumptions
Lots of them on pg 5
Entity Assumption
eco'ic activity can be accounted for when considering an identifiable set of activites (e.g. separate corporation, division, etc)
Going Concern Assumption
for fin'l actg, it is presumed (subject to rebuttal by evidence to the contrary) that the entity will continue to operate in the foreseeable future
Monetary Unit Assumption
it's assumed that money is an appropriate basis by which to measure eco'ic activity. The assumption is that monetary unit does not change over time; thus the effects of inflation are not reflected in the F/S
Periodicity Assumption
eco'ic activity can be divided into meaningful periods
Historical Cost Principle
as a general rule, fin'l info is accounted for and based on cost, not current mkt val
Revenue Recognition Principle
Rec rev when it's 1) earned and 2) realized/realizable
1) earned: when entity has substantially accomplished what it must do to be entitled to the benefits represented by the revenue
2) realiz(ed)(able): rev and gains are recognized when products, merchandise, or other assets are exchanged for cash or claims to cash, or when related assets received or held are readily convertible to known amts of cash or claims to cash (e.g. A/R)
Matching Principle
expenses are NECESSARILY INCURRED to generate revenue. In accordance with [it], all expenses incurred to generate a specific amt of rev in a period are matched against that revenue. [It] does NOT govern the recognition of losses since those are unusual
Accrual Accounting
rev are recognized when earned and realiz(ed)(able) and exp recognized in same period as the related revenue, not necessarily in period in which cash is received
Full Disclosure Principle
It's important that user be given info that would make a difference in dec process but not so much info that the user is impeded in analyzing what's important
Conservatism Principle
If in doubt when selecting from alternative GAAP methods, the method that's least likely to overstate assets (and rev/gains) and underestimate liab (and exp/losses) in the current period should be selected
- recog rev/gains when earning process is complete (or virtually complete)
- recog exp/losses immediately
SFAC No. 6, "Elements of Financial Statements"
these components MUST BE MEASURABLE and meet the recognition requirements
1) Comprehensive Income
2) Rev
3) Exp
4) Gains
5) Losses
6) Assets
7) Liab
8) Equity
9) Investments by Owners
10) Distribution to Owners
NOTE: 9 and 10 are EXCLUDED from C.I.
Comprehensive Income
includes all differences between beg equity and ending equity EXCEPT t'actions made with owners
Revenues
inflows, enhancements of assets, or reductions in liabilities from delivering G/S as a part of NORMAL OPERATIONS (recurring; what you're in business for). Recognize this at GROSS amount (LESS allowances/returns and discounts given)
Expenses
outflows, uses of assets, or incurrence of liabilities from delivering G/S as part of NORMAL OPERATIONS
- consumed resource that has or will generate revenue
Gains
increase in equity from PERIPHERAL TRANSACTIONS (non-operating activities) and other events except revenue and investments from owners

i.e. it's a recognition of an asset either not in the ordinary course of business or WITHOUT THE INCURRENCE OF AN EXPENSE
Losses
decreases in equity from PERIPHERAL TRANSACTIONS and other events except expenses and distributions to owners

i.e. it's a cost expiration either not in the ordinary course of business or WITHOUT THE GENERATION OF REVENUE
Assets
probable future economic benefits to be received by a co as a result of past transactions or events; valuation accounts may used to show reductions to or increases in a(n) _______ that reflect adjustments beyond its historical cost or carrying value
Liabilities
probable future sacrifice of economic benefits arising from a present obligation to transfer assets or provide services to the other company in the future as a result of past transactions or events
Equity
the residual interest in a company that remains after deducting its liabilities
Investments by Owners
the increase in assets from transfers of cash, property, or services from the owners
- i.e. it's contributed capital
Distribution to Owners
the decrease in assets from transfers of cash, property, or services to the owners
Capital
represents equity to which the owners have a claim
Capital Maintenance Adjustments def'n
increases and decreases in equity arising from the revaluation or restatement of assets and liabilities
Capital Maintenance Adjustments
the IASB's Framework uses this account, rather than inv'ts by owners and distributions to owners
Capital Maintenance Concept(s) (of income recognition)
income is not recognized until a) capital has been maintained* or b) there has been a full recovery of costs

*referring to the change in net assets from beg to end of year; 2 ways: FINANCIAL and PHYSICAL
Financial Capital Maintenance
income = change in $ amt of net assets excluding transactions with owners
Physical Capital Maintenance
income = increase in physical capacity
Five Elements of Present Value Measurement
FASB ID'd these to be used as the basis for determining the measurement objective

1) estimate of future CF
2) expectations about timing variations of future CF
3) time value of money (the risk-free rate of interest)
4) the price for bearing uncertainty
5) other factors (e.g. liquidity issues and market imperfections)
Fair Value Objective
if FV can't be determined in the marketplace, the objective must be to obtain an estimate of FV (e.g. a PV of future CF)
PV computations
1) Traditional Approach
2) Expected Cash Flows Approach
Traditional Approach
may be used when assets and liabilities have contractual (i.e. fixed) CF and are not expected to vary

- interest rate selection is paramount
Expected Cash Flows Approach
uses only the risk-free rate of return as the discount rate and then turns its attention to the expected future CF, considering uncertainties (e.g. default risk) as adjustments to the future CF

- used for more complex cases
- considers range of possible CF and assigns a (subjective) probability to each CF in the range to determine the weighted-average (or "expected") future CF
- adjustments to expected CF in complex PV computations (rather than interest rate adjustments) are required for uncertainties (e.g. default risk)
Expected CF - Liability Measurement
when estimating PV, should consider
1) costs to settle
2) credit standing of the co
Catch-up Approach
changes estimated future CF by adjusting the carrying amt of an asset or liability to the PV determined using the revised estimates and discount using the original effective interest rate
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