Chapter 2

The Pursuit of the

Conceptual
Framework
Introduction

What is the conceptual framework?

The Early Theorists
Paton and Canning
DR Scott and his conceptual
framework
 Early Authoritative and Semi-authoritative Organizational
Attempts to Develop the Conceptual Framework of Accounting

A Tentative
A
An
Statement of Statement Introduction
Accounting of to Corporate
Principles
Affecting
Accounting Accounting
Principles Standards
Corporate ARSs
Reports
No. 1
APB and
Statement ASOBAT No. 3
No. 4
 The Trueblood Committee

Committee report specified the following

four information needs of users:

1. Making decisions concerning the use of limited

resources
2. Effectively directing and controlling organizations
3. Maintaining and reporting on the custodianship of
resources
4. Facilitating social functions and controls
Objectives of financial reporting
 Statement on Accounting Theory and Theory
Acceptance

Rationale for the committee’s

approach
The approaches to accounting theory
were condensed into
1. Classical
2. Decision Usefulness
3. Information Economics.
Criticisms of the approaches to theory
 The FASB’s Conceptual Framework Project

The objectives identify the goals

and purposes of financial
accounting; whereas, the fundamentals are the
underlying concepts that help achieve those
objectives.
These concepts are designed to provide guidance in:
1. Selecting the transactions, events and circumstances to be
accounted for
2. Determining how the selected transactions, events, and
transactions should be measured
3. Determining how to summarize and report the results of
events, transactions and circumstances.
 SFAC No. 1 “Objectives of Financial
Reporting By Business Enterprises”

1. Assess cash flow prospects

2. Report on enterprise resources,
claims against resources and changes in them
3. Report economic resources, obligations and owners
equity
4. Report enterprise performance and earnings
5. Evaluate liquidity, solvency, and flow of funds
6. Evaluate management stewardship and performance
7. Explain and interpret financial information
No. 2 “Qualitative Characteristics of
Accounting Information

Addresses the question: What

makes accounting information
useful?
Develops a Hierarchy of Accounting
Qualities
A Hierarchy of Accounting Qualities
Users of Accounting Decision makers
Information and their characteristics
(for example, understanding
of prior knowledge)

Pervasive Constraint Benefits > Costs

Understandability
User-specific qualities

Decision Usefulness

Primary Decision-specific Relevance Reliability

qualities

Verifiability Representational
Timeliness
Faithfulness
Ingredients of
primary qualities Predictive Neutrality
Feedback
value value

Comparability and Consistency

Threshold for
recognition Materiality
 No. 5 “Recognition and Measurement in Financial
Statements of Business Enterprises”

Sets forth recognition criteria and

guidance on what information should be
incorporated into financial statements and when
this information should be reported
Defined comprehensive income as:
Revenues Earnings
Less: Expenses Plus or minus cumulative accounting
adjustments
Plus: Gains Plus or minus other non-owner changes in
equity
Less: Losses
= Earnings = Comprehensive Income
 No. 5 “Recognition and Measurement in Financial
Statements of Business Enterprises”

Measurement Issues
1. Definitions.
 The item meets the definition of an element contained in SFAC
No. 6.
2. Measurability.
 It has a relevant attribute measurable with sufficient reliability.
3. Relevance.
 The information about the item is capable of making a difference
in user decisions.
4. Reliability.
 The information is representationally faithful, verifiable, and
neutral.
 No. 6 “The Elements of
Financial Statements”

Defines the ten elements of

financial statements that are used
to measure the performance and
position of economic entities
These elements are discussed
in more depth in Chapters 6
and 7.
 SFAC No. 7 “Using Cash Flow Information and
Present Value in Accounting Measurements”

Accounting measurement is a very broad topic.

Consequently, the FASB focused on a series of questions relevant to
measurement and amortization conventions that employ present value
techniques. Among these questions are:

What are the objectives of using present value in the initial

recognition of assets and liabilities? And, do these objectives differ
in subsequent fresh-start measurements of assets and liabilities?
Does the measurement of liabilities at present value differ from the measurement of assets?

How should the estimates of cash flows and interest rates be developed?

What are the objectives of present value when used in conjunction with the amortization of assets and
liabilities?

How should present value amortizations be used when the estimates of

cash flows change?
 SFAC No. 7 “Using Cash Flow Information and Present Value in
Accounting Measurements”

Present value measurements that fully captures the

economic differences between assets should include
the following elements:
1. An estimate of the future cash flows
2. Expectations about variations in the timing of those
cash flows
3. The time value of money represented by the risk-
free rate of interest
4. The price for bearing the uncertainty
5. Other, sometimes unidentifiable, factors including
illiquidity and market imperfections
 SFAC No. 7 “Using Cash Flow Information and
Present Value in Accounting Measurements”

Approaches to present value

1. Traditional
2. Expected cash flow

Incorporating probabilities
The objective is to estimate the value of the
assets required currently to settle the liability
with the holder or transfer the liability to an
entity with a comparable credit standing
Use of the interest method
Principles Based vs. Rules Based Accounting
Standards

Continuum ranging from

highly rigid standards on one end

to general definitions of economics-based concepts o

the other end.
 Example: Goodwill
Previous practice:
Goodwill is to be amortized over a 40 life until it is fully
amortized.

New FASB rule:

Goodwill is not amortized.
Any recorded goodwill is to be tested for impairment
and written down to its current fair value on an annual
basis.
 FASB Questions

1. Do you support the Board’s proposal for a principles-based approach to U. S.

standard setting?
Will that approach improve the quality and transparency of U. S. financial
accounting and reporting?
2. Should the Board develop an overall reporting framework as in IAS 1?
If so, should that framework include a true and fair override?
3. Under what circumstances should interpretive and implementation guidance
be provided under a principles-based approach to U.S. standard setting?
Should the Board be the primary standard setter responsible for providing that
guidance?
4. Will preparers, auditors, the SEC, investors, creditors, and other users of
financial information be able to adjust to a principles-based approach to U.S.
standard setting?
If not, what needs to be done and by whom?
5. What other factors should the Board consider in assessing the extent to
which it should adopt a principles-based approach to U.S. standard setting?
6. What are the benefits and costs (including transition costs) of adopting a
principles-based approach to U.S. standard setting?
How might those benefits and costs be quantified?
Principles Based vs. Rules Based Accounting
Standards

The AAA’s position

Dissenting opinion
 Prepared by Kathryn Yarbrough, MBA

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