CONCEPTUAL FRAMEWORK

OF ACCOUNTING
 Generally accepted accounting principles are a
set of rules and practices that are recognized as a
general guide for financial reporting purposes.
 Generally accepted means that these principles
must have substantial authoritative support.
 The Institute of Chartered Accountants of
Pakistan (ICAP) is responsible for developing
accounting principles in Pakistan.
 CONCEPTUAL FRAMEWORK

 The conceptual framework consists of:

– objective of financial reporting,
– qualitative characteristics of accounting
information,
– elements of financial statements, and
– recognition and measurement criteria
(assumptions, principles, and constraints).
 OBJECTIVE OF FINANCIAL
REPORTING

 The objective of financial reporting is to

provide information that is useful for
decision-making
 QUALITATIVE CHARACTERISTICS
OF ACCOUNTING INFORMATION
 The accounting alternative selected should be
one that generates the most useful financial
information for decision making.
 To be useful, information should possess the
following qualitative characteristics:
1. understandability
2. relevance
3. reliability
4. comparability and consistency
 UNDERSTANDABILITY

 Information must be understandable by its

users.
 Users are assumed to have a reasonable
comprehension of, and ability to study, the
accounting, business, and economic
concepts needed to understand the
information.
 RELEVANCE

 Accounting information is relevant if it

makes a difference in a decision.
 Relevant information helps users forecast
future events (predictive value),
or it confirms or corrects prior
expectations (feedback value).
 Information must be available
to decision makers before it
loses its capacity to influence
their decisions (timeliness).
 RELIABILITY

 Reliability of information means that the

information is free of error and bias – it
can be depended on.
 To be reliable, accounting information
must be verifiable – there must be proof
that it is free of error and bias.
 The information must be a faithful
representation of what it purports to be – it
must be factual.
 COMPARABILITY AND
CONSISTENCY
 Comparability means that the information
should be comparable with accounting
information about other enterprises.
 Consistency means that the same accounting
principles and methods should be used from
year to year within a company.

2000 2001 2003

 RECOGNITION AND
MEASUREMENT CRITERIA
 Recognition and measurement criteria used by accountants to
solve practical problems include assumptions, principles, and
constraints.
 Assumptions provide a foundation for the accounting process.
 Principles indicate how economic events should be reported in
the accounting process.
 Constraints permit a company to modify generally accepted
accounting principles without reducing the usefulness of the
reported information.

Assumptions Principles Constraint

Going concern Revenue recognition s
Cost - benefit
Monetary unit Matching Materiality
Economic entity Full disclosure
Time period Cost
 GOING CONCERN
ASSUMPTION
The going concern assumption assumes that the
enterprise will continue to operate in the
foreseeable future.
Implications: capital assets are recorded at cost
instead of liquidation value, amortization is used,
items are labeled as current or non-current.
 MONETARY UNIT ASSUMPTION
 The monetary unit assumption states that only
transaction data capable of being expressed in
terms of money should be included in the
accounting records of the economic entity.
 Also assumes unit of measure ($) remains
sufficiently stable over time. Ignores inflationary
and deflationary effects.

Customer satisfaction
Should not be
included in Percentage of
accounting records international employees
Should be included
in accounting records
Salaries paid
ECONOMIC ENTITY ASSUMPTION

The economic entity assumption states that

economic events can be identified with a
particular unit of accountability.
Example: Harvey’s activities can
be distinguished from those of
other food services such as Swiss
Chalet.
 TIME PERIOD ASSUMPTION

The time period assumption states that the

economic life of a business can be divided
into artificial time periods.
Example: months, quarters, and years

2000 2001 2003

QTR 1 JAN FEB MAR APR
QTR 2 MAY JUN JUL
QTR 3 AUG SEPT OCT
QTR 4 NOV DEC
REVENUE RECOGNITION PRINCIPLE

 The revenue recognition principle says

that revenue should be recognized in the
accounting period in which it is earned.
– Production/sales essentially complete
– Revenues measurable
– Collection reasonably assured
– Expenses determinable
 MATCHING PRINCIPLE

 Expense recognition is traditionally tied to

revenue recognition.
 This practice – referred to as the matching
principle – dictates that expenses be
matched with revenues in the period in
which efforts are expended to generate
revenues.
 FULL DISCLOSURE PRINCIPLE
 The full disclosure principle requires that
circumstances and events that make a
difference to financial statement users be
disclosed.
 Compliance with the full disclosure principle
is accomplished through
1. the data in the financial statements and
2. the notes that accompany the statements.
 A summary of significant accounting policies
is usually the first note to the financial
statements.
 COST PRINCIPLE
 The cost principle dictates that assets are
recorded at their historic cost.
 Cost is used because it is both relevant and
reliable.
1. Cost is relevant because it represents the
price paid, the assets sacrificed, or the
commitment made at the date of
acquisition.
2. Cost is reliable because it is objectively
measurable, factual, and verifiable.
 CONSTRAINTS IN ACCOUNTING
 Constraints permit a company to modify
generally accepted accounting principles without
reducing the usefulness of the reported
information.
 The constraints are cost-benefit and materiality.
1. Cost-benefit means that the value of
information should be greater than the cost of
providing it.
2. Materiality relates to an item’s impact on a
firm’s overall financial condition and operations.
 INTERNATIONAL
ACCOUNTING STANDARDS
 World markets are intertwined.
 The International Accounting Standard Board
(IASB) has more than 150-member accounting
organizations representing more than 110
countries.
 The IASB has issued over 40
InternationalAccounting Standards to obtain
uniformity in international accounting
practices.