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Chapter 2

Chapter 2 – Conceptual framework.docx

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ACC 414
Else Grech

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Chapter 2 – Conceptual framework CONCEPTUAL FRAMEWORK  Conceptual framework: A coherent system of interrelated objectives and fundamentals that can lead to consistent standards and that prescribes the nature, function, and limits of financial accounting and financial statements  Rationale for conceptual framework o Standard setting should build on an established body of concepts and objectives.  Resulting in a coherent set of standards and rules.  Such framework should increase financial statement users understanding of and confidence in financial reporting (as well of comparability of different companies) o Should be possible to solve new and emerging practical problems more quickly  Doing so by using good judgment and with the help of a universally accepted conceptual framework.  Development of the conceptual framework OBJECTIVE OF FINANCIAL REPORTING  Qualitative characteristics of useful information o Determining which alternative gives the most useful information for decision making purposes (decision usefulness) o Fundamental qualitative characteristics  Relevance  capability of making a difference in a decision 1  It needs predictive value: information that helps users make predictions about the final outcome of past/present/future events  Feedback value: information that helps users confirm or correct their previous expectations  Representational faithfulness: information that reflects the underlying economic substance of an event or transaction (transparency)  Information that is complete, neutral and free from material error or bias  Enhancing qualitative characteristics o Comparability: information that enables users to identify the real similarities and differences in economic phenomena. o Verifiability: where knowledgeable, independent users achieve similar results or reach consensus regarding the accounting for a particular transaction o Timeliness: information must be available to decision makers before it loses its ability to influence their decision o Understandability: Users need to have reasonable knowledge of business financial accounting in order to understand the information in financial statements  Financial information must be of sufficient quality and clarity that it allows reasonably informed users to see its significance  Users have the responsibility to review and analyze the information with reasonable diligence  Tradeoffs  it is not always possible for financial information to have all the enhancing qualities of useful information  Contraints  things to consider o Materiality: An items impact on a firm’s overall financial operations. Information that would influence or change the jusgement of a reasonable person.  Rule of thumb: any item representing 5% or more of income from continuing operations after tax is considered material  Both qualitative and quantitative factors must be considered in determining whether an item is material o Cost versus Benefit: the costs of providing the information must be weighed against the benefits that can be had from using the information  Elements of financial statements o Assets: Something that involve present economic resources that the entity has a right or access to where others do not o Liabilities: represent and economic burden/obligation that is enforceable  Contructive obligations: obligations that arise though past or present practice that signals that the company acklowledges a potential economic burden (I stand by my product)  Performance obligations: where an entity agrees to provide a future service or delivery o Equity: residual interest in the assets of an entity that remains after deducting liabilities
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