Intermediate: Accounting

Intermediate Accounting
Seventeenth Edition
Kieso; Weygandt; Warfield
Chapter 2
Conceptual Framework for

Financial Reporting
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Learning Objectives
After studying this chapter, you should be able to:
1. Describe the usefulness of a conceptual framework
and the objective of financial reporting.
2. Identify the qualitative characteristics of accounting
information and the basic elements of financial
statements.
3. Review the basic assumptions of accounting.
4. Explain the application of the basic principles of
accounting.
Copyright ©2019 John Wiley & Sons, Inc. 2

Preview of Chapter 2 (1 of 3)
Conceptual Framework for Financial Reporting
Conceptual Framework
• Need for a conceptual framework
• Development of a conceptual framework
• Overview of the conceptual framework
• Basic objective

Fundamental Concepts
• Qualitative characteristics of accounting information
• Basic elements
Assumptions
• Economic entity
• Going concern
• Monetary unit
• Periodicity

Measurement, Recognition, and Disclosure
Concepts
• Basic principles of accounting
• Cost constraint
• Summary of the structure

Learning Objective 1
Describe the Usefulness of a
Conceptual Framework and the
Objective of Financial Reporting

Need for a Conceptual Framework
• Enables the FASB to issue more useful and consistent
pronouncements over time
• To solve new and emerging practical problems
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Development of a Conceptual
Framework
The FASB has issued seven Statements of Financial Accounting Concepts
(SFAC) for business enterprises.
SFAC No. 1 Objectives of Financial Reporting (superseded by S FAC No. 8)
SFAC No. 2 Qualitative Characteristics of Accounting Information (superseded by S FAC No.
8)
SFAC No. 3 Elements of Financial Statements of Business Enterprises (superseded by S FAC
No. 6)
SFAC No. 5 Recognition and Measurement in Financial Statements of Business Enterprises
SFAC No. 6 Elements of Financial Statements (replaces S FAC No. 3)
SFAC No. 7 Using Cash Flow Information and Present Value in Accounting Measurements
SFAC No. 8 The Objective of General Purpose Financial Reporting and Qualitative
Characteristics of Useful Financial Information (replaces S FAC Nos. 1 and 2)

Overview of the Conceptual
Framework
• First Level = Objective of Financial Reporting
• Second Level = Qualitative Characteristics and Elements
• Third Level = Recognition, Measurement, and
Disclosure Concepts

Overview
of the
Conceptual
Framework
chart

Basic Objective
To provide financial information about the reporting
entity that is useful to present and potential equity
investors, lenders, and other creditors in making
decisions about providing resources to the entity.

Review Question
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.

Review Question Answer
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. Answer: The objectives and concepts for use in developing
standards of financial accounting and reporting.
d. The hierarchy of sources of generally accepted accounting
principles.

Identify the Qualitative Characteristics
of Accounting Information and the
Basic Elements of Financial Statements

Fundamental Concepts
Qualitative Characteristics of Accounting Information
“The FASB identified the qualitative characteristics of

accounting information that distinguish better (more
useful) information from inferior (less useful) information
for decision-making purposes.”

Qualitative Characteristics

Fundamental
Quality—
Relevance (1 of 5)

Fundamental Quality—Relevance (2 of 5)
To have relevance, accounting information must be capable of

making a difference in a decision.

Financial information has predictive value if it has value as an input to

predictive processes used by investors to form their own expectations
about the future.
Relevant information also helps users confirm or correct prior

expectations.

Information is material if omitting it or misstating it could

influence decisions that users make on the basis of the reported
financial information.

Fundamental
Quality—
Faithful
Representation
(1 of 5)

Faithful Representation (2 of 5)
Faithful representation means that the numbers and descriptions

match what really existed or happened.

Completeness means that all the information that is necessary for

faithful representation is provided.

Neutrality means that a company cannot select information to

favor one set of interested parties over another.

An information item that is free from error will be a more accurate

(faithful) representation of a financial item.

Enhancing
Qualities (1 of 6)

Enhancing Qualities (2 of 6)
Enhancing qualitative characteristics distinguish more-useful

information from less-useful information.

Information that is measured and reported in a similar manner for

different companies is considered comparable.

Verifiability occurs when independent measurers, using the same

methods, obtain similar results.

Timeliness means having information available to decision-makers

before it loses its capacity to influence decisions.

Understandability is the quality of information that lets reasonably

informed users see its significance.

Basic
Elements (1 of 6)

Basic Elements (2 of 6)
Assets. Probable future economic benefits obtained or
controlled by a particular entity as a result of past
transactions or events.
Liabilities. Probable future sacrifices of economic benefits
arising from present obligations of a particular entity to
transfer assets or provide services to other entities in the
future as a result of past transactions or events.
Equity. Residual interest in the assets of an entity that
remains after deducting its liabilities.

Investments by Owners. Increases in net assets of a
particular enterprise resulting from transfers to it from
other entities of something of value to obtain or increase
ownership interests (or equity) in it.
Distributions to Owners. Decreases in net assets of a
particular enterprise resulting from transferring assets,
rendering services, or incurring liabilities by the
enterprise to owners.

Comprehensive Income. Change in equity (net assets) of
an entity during a period from transactions and other
events and circumstances from nonowner sources.

Revenues. Inflows or other enhancements of assets of an
entity or settlement of its liabilities (or a combination of
both) during a period from delivering or producing goods,
rendering services, or other activities that constitute the
entity’s ongoing major or central operations.
Expenses. Outflows or other using up of assets or
incurrences of liabilities (or a combination of both) during a
period from delivering or producing goods, rendering
services, or carrying out other activities that constitute the
entity’s ongoing major or central operations.
Gains. Increases in equity (net assets) from peripheral or
incidental transactions of an entity and from all other
transactions and other events and circumstances affecting
the entity during a period except those that result from
revenues or investments by owners.
Losses. Decreases in equity (net assets) from peripheral or
incidental transactions of an entity and from all other
transactions and other events and circumstances affecting
the entity during a period except those that result from
expenses or distributions to owners.
Review the Basic Assumptions of
Accounting

Assumptions
chart

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.

Assumptions
Illustration: 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 Unit
amounts in its financial statements for the
effects of inflation.
(c) Walgreen Co. reports current and noncurrent
classifications in its balance sheet. Going Concern
(d) The economic activities of General Electric

and its subsidiaries are merged for Economic Entity
accounting and reporting purposes.
Explain the Application of the Basic
Principles of Accounting

Basic
Principles
of
Accounting
(1 of 7)

Basic Principles of Accounting (2 of 7)
Measurement Principle – Commonly used measurements
are based on historical cost and fair value.
• Historical cost provides a reliable benchmark for
measuring historical trends
• Fair value information may be more useful
• The Board has given companies the option to use fair
value (fair value option) as the basis for measurement
of financial assets and financial liabilities
• Reporting of fair value information is increasing
Revenue Recognition - requires that companies recognize
revenue in the accounting period in which the
performance obligation is satisfied.
Expense Recognition - “Let the expense follow the
revenues.”

Illustration: Assume the Boeing
Corporation signs a contract to
sell airplanes to Delta Air Lines
for $100 million. To determine
when to recognize revenue,
use the five steps for revenue
recognition shown at right.

Expense Recognition - “Let the expense follow the revenues.”
Type of Cost Relationship Recognition
Product costs: Direct relationship Recognize in period
• Material between cost and of revenue
revenue. (matching).
• Labor
• Overhead
Period costs: No direct Expense as incurred.
• Salaries relationship between
cost and revenue.
• Administrative
costs

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

Illustration: Identify which basic principle of accounting is best described in
each item below.
(a) KC Corporation reports revenue in its income
statement when it is earned instead of when the Revenue Recognition
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. Expense Recognition
(c) Oracle Corporation reports information about

pending lawsuits in the notes to its financial Full Disclosure
statements.
(d) Eastman Kodak Company reports land on its
balance sheet at the amount paid to acquire it, Measurement
even though the estimated fair market value is
greater.
Cost
Constraint chart

Cost Constraint
Cost of providing information must be weighed against
the benefits that can be derived from using it.
In order for rule-making bodies and governmental
agencies to justify requiring a particular measurement or
disclosure, the benefits perceived to be derived from it
must exceed the costs perceived to be associated with it.

Compare the Conceptual Frameworks
Underlying GAAP and IFRS

IFRS Insights (1 of 10)
Relevant Facts
Similarities
• The IASB has recently completed its conceptual framework, whereas
the FASB has not. However, many of the concepts that are covered in
the new IASB conceptual framework are consistent with the FASB
current framework and related standards.
• The objective of financial reporting and the qualitative characteristics
of useful financial information are essentially the same between the
two frameworks.

Relevant Facts
Similarities
• Both frameworks have similar measurement principles, based on
historical cost and fair value concepts. The mixed model (historical cost
and fair value) is essentially the same in the two frameworks. In 2011,
the Boards issued a converged standard on fair value measurement so
that the definition of fair value, measurement techniques, and
disclosures are the same between GAAP and IFRS when fair value is
used in financial statements.

Relevant Facts
Differences
• The IASB gives more emphasis to stewardship in its conceptual
framework. The framework indicates that users need information
about the resources of the entity not only to assess an entity’s
prospects for future cash inflows but also to determine how effectively
and efficiently management has discharged their responsibilities to use
the entity’s existing resources (i.e., stewardship). In other words, the
IASB conceptual framework explicitly discusses the need to provide
information related to stewardship of an entity’s resources as well as
the need for information to help users understand the prospects for
future net cash inflows to the entity.
Relevant Facts
Differences
• The concept of prudence is introduced to support the principle of neutrality in
relation to the purpose of faithful representation. Prudence is defined as the exercise
of caution when making judgments under conditions of uncertainty. As an example,
prudence means that revenues are not overstated, and expenses are not
understated.
• The IASB also clarified two other concepts—measurement uncertainty and
substance over form. The framework indicates that measurement uncertainty does
not prevent information from being useful. However, in some cases the most
relevant information may have such a high degree of uncertainty that the most
useful information is that which is slightly less relevant but is subject to lower
measurement uncertainty.

Relevant Facts
Differences
• Although both GAAP and IFRS are increasing the use of fair value to
report assets, at this point IFRS has adopted it more broadly. As
examples, under IFRS, companies can apply fair value to property, plant,
and equipment; natural resources; and, in some cases, intangible assets.
• The monetary unit assumption is part of each framework. However, the
unit of measure will vary depending on the currency used in the country
in which the company is incorporated (e.g., Chinese yuan, Japanese yen,
and British pound). I FRS makes an explicit assumption that financial
statements are prepared on an accrual basis.

Relevant Facts
Differences
• The economic entity assumption is also part of each framework
although some cultural differences result in differences in its application.
For example, in Japan many companies have formed alliances that are
so strong that they act similar to related corporate divisions although
they are not actually part of the same company. IFRS defines a reporting
entity as one that is required to (or chooses to) prepare financial
statements. A reporting entity does not need to be a legal entity; it
could be a portion of an entity or a combination of entities. GAAP uses a
different definition (more aligned with legal entities).

Relevant Facts
Differences
• The IASB has developed a new conceptual framework. In the revised
conceptual framework, the IASB has introduced two new qualitative
characteristics: prudence and substance over form. Also, the IASB is
making modifications to other parts of its conceptual framework by
revising the definitions of a number of the basic elements. The IASB is
also introducing updated chapters on such items as measurement,
classification of income and expense, derecognition of assets and
liabilities, and the reporting entity.

About the Numbers
Financial Statement Elements
While the conceptual framework that underlies IFRS is very similar to that
used to develop GAAP, the elements identified and their definitions under
IFRS are different. The IASB elements and their definitions are as follows.
Assets. A present economic resource controlled by the entity as a result of
past events. An economic resource is a right that has the potential to
produce economic benefits.
Liabilities. A present obligation of the entity to transfer an economic
resource as a result of past events.
Equity. The residual interest in the assets of the entity after deducting all
its liabilities.

About the Numbers
Financial Statement Elements
Income. Increases in assets, or decreases in liabilities, that result in
increases in equity, other than those relating to contributions from
holders of equity claims.
Expenses. Decreases in assets, or increases in liabilities, that result in
decreases in equity, other than those relating to distributions to holders
of equity claims.

On The Horizon
The FASB now faces a difficult task in attempting to update, modify, and
complete a converged conceptual framework. There are many difficult issues.
For example: How do we trade off characteristics such as highly relevant
information that is difficult to verify? How do we define control when we are
developing Should a single measurement method, such as historical cost or
fair value, be used, or does it depend on whether it is an asset or liability that
is being measured? Hopefully, the recently completed I ASB conceptual
framework will provide many useful concepts for the F ASB in helping it to
complete the revision process for its conceptual framework. We are
optimistic that the revised conceptual framework will be a significant
improvement over its predecessors and will lead to standards that will help
financial statement users to make better decisions.

Copyright
Copyright © 2019 John Wiley & Sons, Inc.
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Intermediate Accounting

Kieso; Weygandt; Warfield

Conceptual Framework for

Copyright ©2019 John Wiley & Sons, Inc. 2

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“The FASB identified the qualitative characteristics of

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To have relevance, accounting information must be capable of

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Financial information has predictive value if it has value as an input to

Relevant information also helps users confirm or correct prior

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Information is material if omitting it or misstating it could

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Faithful representation means that the numbers and descriptions

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Completeness means that all the information that is necessary for

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Neutrality means that a company cannot select information to

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An information item that is free from error will be a more accurate

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Enhancing qualitative characteristics distinguish more-useful

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Information that is measured and reported in a similar manner for

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Verifiability occurs when independent measurers, using the same

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Timeliness means having information available to decision-makers

LO 2 Copyright ©2019 John Wiley & Sons, Inc. 31

Understandability is the quality of information that lets reasonably

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(a) The economic activities of KC Corporation

(d) The economic activities of General Electric

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