The conceptual framework provides a coherent system of objectives and fundamentals that can lead to consistent accounting standards. It establishes the nature, function and limits of financial accounting. The FASB has issued six statements of financial accounting concepts to develop the conceptual framework. The framework consists of three levels - objectives of financial reporting, qualitative characteristics of accounting information, and recognition and measurement concepts. It also identifies basic elements, assumptions, principles and constraints of financial reporting.

1. Chapter
2-1

2. Chapter
2-2
Decision
usefulness
Information about
economic
resources
Conceptual
Framework
First Level: Basic
Objectives
Second Level:
Fundamental
Concepts
Third Level:
Recognition and
Measurement
Need
Development
Qualitative
characteristics
Basic elements
Basic assumptions
Basic principles
Constraints
Financial Accounting and Accounting Standards

3. Chapter
2-3
Conceptual Framework
A conceptual framework is a coherent system of
interrelated objectives and fundamentals that
can lead to consistent standards and it
prescribes the nature, function, and limits of
financial accounting and financial statements.

4. Chapter
2-4
The Need for a Conceptual Framework
To develop a coherent set of standards and rules
To solve new and emerging practical problems
It will increase financial statement users’
understanding of and confidence in financial
reporting.
It will enhance comparability among companies’
financial statements.
Conceptual Framework

5. Chapter
2-5 Objective 2
The FASB has issued six Statements of Financial
Accounting Concepts (SFAC) for business enterprises.
Development of Conceptual Framework
SFAC No.1 - Objectives of Financial Reporting
SFAC No.2 - Qualitative Characteristics of Accounting Information
SFAC No.3 - Elements of Financial Statements (superceded by
SFAC No. 6)
SFAC No.5 - Recognition and Measurement in Financial Statements
SFAC No.6 - Elements of Financial Statements (replaces SFAC No. 3)
SFAC No.7 - Using Cash Flow Information and Present Value in
Accounting Measurements

6. Chapter
2-6
The Framework is comprised of three levels:
First Level = Basic Objectives
Second Level = Qualitative Characteristics and
Basic Elements
Third Level = Recognition and Measurement
Concepts.
Conceptual Framework

7. Chapter
2-7
ASSUMPTIONS
1. Economic entity
2. Going concern
3. Monetary unit
4. Periodicity
PRINCIPLES
1. Measurement
2. Revenue recognition
3. Expense recognition
4. Full disclosure
CONSTRAINTS
1. Cost-benefit
2. Materiality
3. Industry practice
4. Conservatism
OBJECTIVES
1. Useful in investment
and credit decisions
2. Useful in assessing
future cash flows
3. About enterprise
resources, claims to
resources, and
changes in them
ELEMENTS
Assets, Liabilities, and Equity
Investments by owners
Distribution to owners
Comprehensive income
Revenues and Expenses
Gains and Losses
Illustration 2-7
Conceptual Framework
for Financial Reporting
First level
Second level
Third
level
LO 2 Describe the FASB’s
efforts to construct a
conceptual framework.
QUALITATIVE
CHARACTERISTICS
Relevance
Reliability
Comparability
Consistency

8. Chapter
2-8
Financial reporting should provide information that:
(a) is useful to present and potential investors and creditors and
other users in making rational investment, credit, and similar
decisions.
(b) helps present and potential investors and creditors and other
users in assessing the amounts, timing, and uncertainty of
prospective cash receipts.
(c) portrays the economic resources of an enterprise, the claims
to those resources, and the effects of transactions, events,
and circumstances that change its resources and claims to
those resources.
First Level: Basic Objectives
LO 3 Understand the objectives of financial reporting.

9. Chapter
2-9
Qualitative Characteristics
“The FASB identified the Qualitative Characteristics
of accounting information that distinguish better
(more useful) information from inferior (less useful)
information for decision-making purposes.”
Second Level: Fundamental Concepts
LO 4 Identify the qualitative characteristics of accounting information.

10. Chapter
2-10
Second Level: Qualitative Characteristics
LO 4 Identify the qualitative characteristics of accounting information.
Illustration 2-2
Hierarchy of Accounting
Qualities

11. Chapter
2-11
ASSUMPTIONS
1. Economic entity
2. Going concern
3. Monetary unit
4. Periodicity
CONSTRAINTS
1. Cost-benefit
2. Materiality
3. Industry practice
4. Conservatism
OBJECTIVES
1. Useful in investment
and credit decisions
2. Useful in assessing
future cash flows
3. About enterprise
resources, claims to
resources, and
changes in them
QUALITATIVE
CHARACTERISTICS
Relevance
Reliability
Comparability
Consistency
ELEMENTS
Assets, Liabilities, and Equity
Investments by owners
Distribution to owners
Comprehensive income
Revenues and Expenses
Gains and Losses
Illustration 2-7
Conceptual Framework
for Financial Reporting
First level
Second level
Third
level
LO 4 Identify the qualitative
characteristics of
accounting information.
PRINCIPLES
1. Measurement
2. Revenue recognition
3. Expense recognition
4. Full disclosure
Relevance and Reliability

12. Chapter
2-12 LO 4
Second Level: Qualitative Characteristics
Primary Qualities:
Relevance – making a difference in a decision.
Predictive value
Feedback value
Timeliness
Reliability
Verifiable
Representational faithfulness
Neutral - free of error and bias
In the proposed converged conceptual framework, reliability will be
replaced with “faithful representation” as one of the primary qualitative
characteristics that must be present for information to be useful.

13. Chapter
2-13
ASSUMPTIONS
1. Economic entity
2. Going concern
3. Monetary unit
4. Periodicity
CONSTRAINTS
1. Cost-benefit
2. Materiality
3. Industry practice
4. Conservatism
OBJECTIVES
1. Useful in investment
and credit decisions
2. Useful in assessing
future cash flows
3. About enterprise
resources, claims to
resources, and
changes in them
QUALITATIVE
CHARACTERISTICS
Relevance
Reliability
Comparability
Consistency
ELEMENTS
Assets, Liabilities, and Equity
Investments by owners
Distribution to owners
Comprehensive income
Revenues and Expenses
Gains and Losses
First level
Second level
Third
level
LO 4 Identify the qualitative
characteristics of
accounting information.
Illustration 2-7
Conceptual Framework
for Financial Reporting
PRINCIPLES
1. Measurement
2. Revenue recognition
3. Expense recognition
4. Full disclosure
Comparability and Consistency

14. Chapter
2-14 LO 4 Identify the qualitative characteristics of accounting information.
Second Level: Qualitative Characteristics
Secondary Qualities:
Comparability – Information that is measured and
reported in a similar manner for different
companies is considered comparable.
Consistency - When a company applies the same
accounting treatment to similar events from period
to period.

15. Chapter
2-15
ASSUMPTIONS
1. Economic entity
2. Going concern
3. Monetary unit
4. Periodicity
CONSTRAINTS
1. Cost-benefit
2. Materiality
3. Industry practice
4. Conservatism
OBJECTIVES
1. Useful in investment
and credit decisions
2. Useful in assessing
future cash flows
3. About enterprise
resources, claims to
resources, and
changes in them
QUALITATIVE
CHARACTERISTICS
Relevance
Reliability
Comparability
Consistency
ELEMENTS
Assets, Liabilities, and Equity
Investments by owners
Distribution to owners
Comprehensive income
Revenues and Expenses
Gains and Losses
First level
Second level
Third
level
LO 5 Define the basic
elements of financial
statements.
Illustration 2-7
Conceptual Framework
for Financial Reporting
PRINCIPLES
1. Measurement
2. Revenue recognition
3. Expense recognition
4. Full disclosure
Basic Elements

16. Chapter
2-16
Investment by owners
Distribution to owners
Comprehensive income
Revenue
Expenses
Gains
Losses
Second Level: Basic Elements
Concepts Statement No. 6 defines ten interrelated
elements that relate to measuring the performance and
financial status of a business enterprise.
Assets
Liabilities
Equity
“Moment in Time” “Period of Time”
LO 5 Define the basic elements of financial statements.

17. Chapter
2-17
Elements of financial statement
Assets – probable future economic benefits
Liabilities – probable future sacrifices of
economic benefits
Equity – residual interest in the assets of an
entity that remains after deducting its
liabilities (also referred to as the ownership
interests).

18. Chapter
2-18
Elements of financial statement
Comprehensive Income – Includes all changes
in equity (presented on the Statment of
Owners’ Equity) during a period except those
resulting from investments by owners and
distributions to owners.
Example
+/- Unrealized Gains/Losses
+/- Foreign Currency Translations
+/- Minimum Pension Liability
Adjustment

19. Chapter
2-19
Elements of financial statement
Revenues – Inflows or other enhancements of
assets of an entity or settlement of its
liabilities occurring from ongoing major or
central operations of the business
Expenses – Outflows or other using up of
assets or incurrence of liabilities occurring
from ongoing major or central operations of
a business.

20. Chapter
2-20
Elements of financial statement
Gains – Increases in equity (net assets) from
peripheral or incidental transactions of an
entity.
Losses – Decreases in equity (net assets) from
peripheral or incidental transactions of an
entity.
(ex. Gains/Losses from sale of an operational
asset, or gains/losses from settlement of a
lawsuit)

21. Chapter
2-21
Elements of financial statement
Investment by owners: increase in net assets
of a particular enterprise resulting from
transfers to it from other entities of
something of value to obtain or increase
ownership interests in it.
Distributions to owners: decrease in net assets
of a particular enterprise resulting from
transferring assets, rendering services, or
incurring liabilities by the enterprise to
owners.

22. Chapter
2-22
Third Level: Recognition and Measurement
The FASB sets forth most of these concepts in its
Statement of Financial Accounting Concepts No. 5,
“Recognition and Measurement in Financial Statements
of Business Enterprises.”
ASSUMPTIONS
1. Economic entity
2. Going concern
3. Monetary unit
4. Periodicity
PRINCIPLES
1. Measurement
2. Revenue recognition
3. Expense recognition
4. Full disclosure
CONSTRAINTS
1. Cost-benefit
2. Materiality
3. Industry practice
4. Conservatism
LO 6 Describe the basic assumptions of accounting.

23. Chapter
2-23
Economic Entity – company keeps its activity
separate from its owners and other businesses.
Going Concern - company to last long enough to fulfill
objectives and commitments.
Monetary Unit - money is the common denominator.
Periodicity - company can divide its economic
activities into time periods.
Third Level: Assumptions
LO 6 Describe the basic assumptions of accounting.

24. Chapter
2-24
Revenue Recognition - generally occurs (1) when
realized or realizable and (2) when earned.
Realized – revenues are realized when goods or services
are exchanged for cash or claims to cash
Realizable – revenues are realizable when assets received
or held are readily convertible into cash or claims to
cash
Earned – revenues are earned when the entity has
substantially accomplished what it must do to be
entitled to the benefits represented by the
revenues.
Third Level: Principles

25. Chapter
2-25
Expense Recognition - “Let the expense follow the
revenues.” dictates that efforts (expenses) be
matched with accomplishments (revenues) whenever
it is reasonable and practical to do so.
Third Level: Principles
LO 7 Explain the application of the basic principles of accounting.

26. Chapter
2-26
Full Disclosure – providing information that is of
sufficient importance to influence the judgment and
decisions of an informed user.
Provided through:
Financial Statements
Notes to the Financial Statements
Supplementary information
Third Level: Principles
LO 7 Explain the application of the basic principles of accounting.

27. Chapter
2-27
Cost Benefit – the cost of providing the information
must be weighed against the benefits that can be
derived from using it.
Materiality - an item is material if its inclusion or
omission would influence or change the judgment of
a reasonable person.
Industry Practice - the peculiar nature of some
industries and business concerns sometimes requires
departure from basic accounting theory.
Conservatism – when in doubt, choose the solution
that will be least likely to overstate assets and
income.
Third Level: Constraints