2. Conceptual Framework For Financial Reporting

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Assumption

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One of the parts in the third level of the conceptual framework; a concept that the accounting profession assumes as foundational for the financial accounting structure. There are four basic assumptions: (1) economic entity, (2) going concern, (3) monetary unit, and (4) periodicity.

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Comparability

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An enhancing qualitative characteristic of accounting information, which describes information that is measured and reported in a similar manner for different companies. Comparability enables users to identify the real similarities and differences in economic activities between companies.

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Completeness

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One of the ingredients of the fundamental quality of faithful representation. Completeness means that all the information necessary for faithful representation is provided.

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Conceptual framework

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For the accounting profession, a coherent system of objectives and fundamentals established by the FASB, which determine the nature, function, and limits of financial accounting and which lead to consistent accounting standards.

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Confirmatory value

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One of the ingredients of the fundamental quality of relevance, it helps to confirm or correct prior expectations based on previous evaluations of financial reporting information.

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Conservatism

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The convention in accounting that dictates that when in doubt, choose the solution that will be least likely to overstate assets and income. The conceptual framework indicates that prudence or conservatism is generally in conflict with the quality of neutrality, because being prudent or conservative can lead to bias in the reported financial position and financial performance.

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Consistency

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An aspect of comparable information, which indicates that a company applied the same accounting treatment to similar events from period to period. A company can change methods, but it must first demonstrate that the newly adopted method is preferable to the old and then must disclose in the financial statements the nature and effect of the accounting change.

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Cost constraint (cost-benefit relationship)

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An accounting constraint that requires that the costs of providing financial information be weighed against the benefits that can be derived from using it. The constraint applies to informational requirements established by standard-setting bodies and governmental agencies as well as to companies reporting financial information.

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Economic entity assumption

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An assumption that economic activity can be identified with a particular unit of accountability, by keeping an enterprise's economic activity separate and distinct from that of its owners and any other business unit. The entity assumption refers to economic, rather than legal, entities.

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Elements, basic

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Definitions of the items that make up any theoretical structure. For accounting, there are ten basic accounting elements: assets, liabilities, equity, investments by owners, distributions to owners, comprehensive income, revenues, expenses, gains, and losses. These terms constitute the language of business and accounting.

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Expense recognition principle

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Accounting principle that dictates that the recognition of expenses is related to net changes in assets and earning revenues, that is, “let the expense follow the revenues.”

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Fair value

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The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

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Fair value option

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The choice allowed by the FASB to use fair value in the financial statements as the basis of measurement for financial assets and liabilities. Under the fair value option, the item is recorded at fair value at each reporting date, and unrealized holding gains or losses are reported as part of net income.

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Fair value principle

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GAAP-based principle that calls for the use of fair value measurements in the financial statements.

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Faithful representation

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One of the qualitative characteristics of accounting information. To be a faithful representation, information must be complete, free from error, and neutral.

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Financial statements

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The structured means of communicating financial information, through the balance sheet, income statement, statement of cash flows, and statement of owners' equity.

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Free from error

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View that information that is accurate will be more representationally faithful.

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Full disclosure principle

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Accounting principle that dictates that in deciding what information to report, companies follow the general practice of providing information that is of sufficient importance to influence the judgment and decisions of an informed user. It recognizes that the nature and amount of information included in financial reports reflects a series of judgmental trade-offs between sufficient detail that makes a difference to users, sufficient condensation to make the information understandable, and the costs and benefits of providing the information.

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General-purpose financial reporting

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The format for providing information to decision-makers at the least cost.

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Going concern assumption

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Accounting assumption that a company will continue in operation for the foreseeable future. Only in situations in which liquidation appears imminent is the assumption inapplicable.

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Historical cost principle

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An accepted accounting principle that companies account for and report most assets and liabilities on the basis of acquisition price. To the extent that historical cost is free from error and neutral, it contributes to faithful representation.

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Matching principle

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Accounting principle that dictates that efforts (expenses) be matched with accomplishment (revenues) whenever it is reasonable and practicable to do so. This linking of expense recognition to revenue recognition is popularly expressed as, “Let the expense follow the revenues.”

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Materiality

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A company-specific aspect of relevance, an item is said to be material if its inclusion or omission would influence or change the judgment of a reasonable person; it is immaterial, and therefore irrelevant, if it would have no impact on a decision-maker. The point involved is one of relative size and importance; that is, both quantitative and qualitative factors should be considered.

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Monetary unit assumption

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Accounting assumption that money is the common denominator of economic activity and provides an appropriate basis for accounting measurement and analysis.

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Neutrality

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One of the ingredients of the fundamental quality of faithful representation, neutrality indicates that a company cannot select information to favor one set of interested parties over another. Unbiased information must be the overriding consideration.

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Notes to financial statements

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A set of disclosures in a company's financial statements that further explain the items presented in the main body of the statements. The additional information provided in the notes does not have to be quantifiable, nor does it need to qualify as an accounting element. Notes to the financial statements are considered an integral part of the statements.

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Objective of financial reporting

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Goal for financial accounting and reporting, established by the accounting profession, which is to provide information about the reporting entity that is useful to present and potential to equity investors, lenders, and other creditors in decisions about providing resources to the entity.

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Period costs

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Costs that attach to a specific accounting period. Examples are officers' salaries and other administrative expenses. Companies charge off such period costs in the immediate period, even though benefits associated with these costs may occur in the future. Period costs are not included as part of inventory cost; instead, they are matched with revenue of a specific time period and expensed as incurred.

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Periodicity (time period) assumption

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Accounting assumption that implies that a company can divide its economic activities into artificial time periods. These time periods vary, but the most common are monthly, quarterly, and yearly.

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Predictive value

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One characteristic of relevant information, indicating that information must help users predict the ultimate outcome of past, present, and future events.

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Principles of accounting

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One of the parts in the third level of the conceptual framework, which details recognition and measurement concepts. The accounting profession generally uses four basic principles of accounting to record transactions: (1) measurement, (2) revenue recognition, (3) expense recognition, and (4) full disclosure.

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Product costs

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Costs that attach to a specific product. Examples are material, labor, and overhead. Companies carry product costs into future periods if they recognize the revenue from the product in subsequent periods.

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Prudence

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The convention in accounting that dictates that when in doubt, choose the solution that will be least likely to overstate assets and income. The conceptual framework indicates that prudence or conservatism is generally in conflict with quality of neutrality, because being prudent or conservative can lead to bias in the reported financial position and financial performance.

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Qualitative characteristics

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Part of the second level of the conceptual framework of accounting; the characteristics of accounting information that distinguish better (more useful) information from inferior (less useful) information for decision-making purposes. The primary qualitative characteristics are relevance and faithful representation.

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Relevance

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One of the qualitative characteristics of accounting information, which describes information capable of making a difference in a decision. Information with no bearing on a decision is irrelevant. To be relevant, information needs have predictive or feedback value and is material.

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Revenue recognition principle

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One of the basic principles of accounting, which dictates that companies recognize revenue in the accounting period in which the performance obligation is satisfied. Generally, recognition at the time of sale provides a uniform and reasonable test.

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Supplementary information

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Information included in the notes to financial statements, which includes details or amounts that present a different perspective from that adopted in the financial statements. It may be quantifiable information that is high in relevance but low in reliability and may include management's explanation of the financial information and its discussion of the significance of that information.

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Timeliness

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An enhancing qualitative characteristic of accounting information, indicating that information should be available to decision-makers before it loses its capacity to influence their decisions.

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Understandability

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An enhancing qualitative characteristic of accounting information that lets reasonably informed users see its significance.

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Verifiability

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An enhancing qualitative characteristic of accounting information, indicating that similar results will occur when independent third parties (e.g., auditors) measure using the same methods.