A conceptual framework of financial accounting deals with fundamental financial reporting issues as guided and prepared by a recognized standard-setting body against which practical problems can be solved easily and effectively.
To help users of financial statements and to develop financial information for the beneficiary, a conceptual framework of Financial Accounting is used that guides financial accounting and reporting system. The basic concepts underlying the conceptual framework of financial accounting are necessary for accounting standards.
Definition of a conceptual framework of Financial Accounting
Investors and creditors use financial information to make their resource allocation decisions successful. They may compare financial information among companies or organizations. To facilitate these comparisons, financial accounting employs a body of standards known as Generally Accepted Accounting Principles often abbreviated GAAP. GAAP are those principles that have substantial authoritative support, such as
FASB standard and interpretations, APB opinions and interpretations, AICPA Accounting Research Bulletins.
A conceptual framework of Financial Accounting is said to be a statement of generally accepted accounting principles (GAAP) which form the frame of reference for which practical problems can be solved effectively.
FASB described the conceptual framework as “a constitution, a coherent system of interrelated objectives and fundamentals that can lead to consistent standards and that prescribe the nature, function, and limits of financial accounting and reporting. The fundamentals are the important concepts of accounting that generally guide the selection of various events to be accounted for, the measurement of those events, and the means of summarizing and conveying them to all the interested parties”. The conceptual framework does not prescribe GAAP. It provides an underlying foundation for accounting standards.
Need for the conceptual framework of Financial Accounting:
- To be useful to all concern standard setting should build on and relate to an established prominent body of concepts & objectives. A coherent set of standards & rules should be the outcome.
- New & emerging practical problems should be more quickly solved by reference to an existing framework of the basic theory.
A conceptual framework generally deals with fundamental financial reporting issues such as the objectives of financial statements, the characteristics (primary and secondary) that make accounting information useful, the basic elements of financial statements (e.g., assets, liabilities, equity, investment by owners, distribution to owners, income, and expenses,gains,losses,comprehensive income), and the concepts for recognising and measuring these elements in the financial statements(Balance sheet ,Income statement, statement of cash flows, statement of shareholders ‘equity, and related disclosures)
A conceptual framework for financial accounting reporting:
- Useful for decision making
- That helps predict cash flows
- about economic resources,
Claim to resources, and changes
In resources and claims.
Investment by owners
Distribution to owners
|Recognition & Measurement Concepts
Statement of Cash flows
Statement of shareholder’s equity
Qualitative Characteristics of Accounting information:
Information must make a difference in meaning for a decision process. To satisfy the objectives of the enterprise information should possess certain characteristics.
These characteristics are two types: Primary and secondary qualitative characteristics.
Primary qualitative characteristics
Relevance and reliability–
Relevant information helps users make predictions about the outcome of past, present, and future situations. To be relevant all information must possess predictive value and feedback value. Timeliness is also important of relevance. Information is said to be times when it is available to users early to allow its use in their decision process.
Reliability means the extent to which required information is verifiable, representationally faithful and undoubtedly neutral. Neutrality means that information cannot be selected to favor one set of interested parties over another’s. Reliability assumes the information being relied on is neutral in all respect to parties potentially affected.
Secondary qualitative characteristics
Comparability is the ability to help users see similarities and differences among events and condition of another enterprise.
The consistency of accounting practices over time permits a valid comparison between different periods about the same enterprise.
ELEMENTS OF FINANCIAL ACCOUNTING STATEMENTShttps://youtu.be/16Qv4i3tRDo?t=563
The elements are the building block with which financial statements are constructed–the classes of items that financial statements comprise”.
SFAC no 6 defines the 10 interrelated elements that are most directly related to measuring the performance and financial status of an enterprise.
The 10 elements are (1) Assets (2) Liabilities (3) Equity (4) Investment by owners (5) Distribution to owners (6) Revenues (7) Expenses (8) Gains (9) Loss (10) Comprehensive income.
Assets are probable future economic benefits controlled by the enterprise as a result of past transaction.
Liabilities – represents obligations to other entities.
Equity– is a residual amount, the owner’s interest in assets after subtracting Liabilities.
Investment by owners—are increases in equity resulting from transfers of resources (usually cash or cash equivalent) to a company in exchange for an ownership interest.
Distribution to owners– is decreasing in equity resulting from transfer to owners.
Revenues– are gross inflow resulting from providing goods & services to Customers.
Gains– result from the selling of assets used for an amount greater than the book value.
Expenses are gross outflows incurred in generating revenue.
Losses are net outflows from selling assets used for an amount less than the Book value.
Comprehensive income– is the change in equity of an entity during a period from non-owner transactions.
Recognition and Measurement Concepthttps://youtu.be/16Qv4i3tRDo?t=910 for Financial Accounting:
Recognition relates to the process of admitting information of an entity into the basic
Measurement refers to the process of associating numerical amounts to the elements.
An item should be recognized usually in the basic financial statements of an entity when it meets the following four criteria, subject to a cost-effectiveness constraint and materiality threshold.
Definition- When the item meets the definition of an element of financial statements
Measurability- when the item has a relevant attribute measurable with sufficient reliability.
Relevance when the required information about it is capable of making a difference in user decision making.
Reliability when the information is representationally faithful, verifiable and neutral in all respect.
It involves two choices (1) the choice of a unit of measurement and
(2) The choice of an attribute to be measured by an individual.
The monetary unit or measurement scale used in financial statements is a nominal unit of money. The board admits different attributes such as historical cost, net realizable value, and a present value of future cash flows are used to measure different financial statement elements and practice to continue.
The four basic assumptions underlying GAAP are:-
- Economic entity 2. Going concern 3. Periodicity 4. Monetary unit assumption.
The economic entity assumptions presume that economic event can be identified especially with an economic entity.
Financial statements of an entity presume that the business is a going concern.
The periodicity assumptions allow the life of a company to be divided into artificial time periods to provide timely information.
The monetary unit assumption states that financial statements should be measured in terms of the taka.
Financial Accounting Principles:
Four key broad Financial accounting principles guide accounting practice. (1) The historical cost principle (2) the revenue recognition principle (3) the matching principle (4) the full disclosure principle.
- Historical cost principle states that asset & liability measurement should be based on the amount given or received in the exchange transaction. Historical cost measurement provides important cash flow information and also is highly verifiable.
- Revenue should be recognized when the earning process is virtually complete and collection is reasonably assured. Both revenues recognized criteria usually are met at the point of sale. Generally, revenue is recognized when earned, regardless of when the cash is actually received.
- The matching principle states that expenses are recognized in the same period as the related revenue occur. An expense can be recognized: (1) based on a cause-and-effect relationship between a revenue and expense event. (2) By associating an expense equal with the revenues recognized in a specific time period. (3) By a systematic and more rational allocation to specific time periods (4) and in the period incurred, without regard to related revenues.
- The full disclosure principles mean that the financial reports should include any information that could affect the decision made by external users. Supplemental information is disclosed in a variety of ways, including a) Parenthetical comments b) Disclosure notes c) Supplemental financial statements.