the theoretical framework of accounting

 Definition  Purposes of financial statements  Assumptions and quality features  Elements of financial statements  Acknowledging and measuring the elements of financial statements C

THE THEORETICAL FRAMEWORK OF ACCOUNTING

 Definition

 Purposes of financial statements

 Assumptions and quality features

 Elements of financial statements

 Acknowledging and measuring the elements of financial statements

Capital maintenance

 The necessity

 The rebuttable opinions

 The development history

The necessity

 Creating a solid theoretical basis for the drafting

of accounting standards;

 Minimizing political influences, the lack of

consistency in this process;

 Providing information for the understanding of basic requirements for financial statements

The rebuttable opinions

 The theoretical framework does not solve the real problems in accounting;

 The drafting process of theoretical framework itself

is also influenced by politics;

 The theoretical framework reduces the flexibility in drafting standards;

The development history

 Be launched first in the United States and developed

in the Anglo-Saxon countries

 IAS Framework (1989)

 Have not developed in the countries of the European continent schools

The FASB’s Framework

 Issued by FASB under the form of a series Statement of Financial Accounting Concepts;

 The previous reports/disclosures:

– Statement No 4 of Accounting Principles Board (1970): Basic Concepts and Accounting Principles Underlying Financial Statements of Business Enterprises.

– Trueblood Report (1973): Report of Study Group on the Objectives of Financial Statements.

The FASB’s Framework

SFAC 1 Purposes of the businesses’ financial statements 1978

SFAC 2 The quality standards of accounting

SFAC 3 Elements of financial statements 1980

SFAC 4 Purposes of the non-profit organizations’

financial statements 1980

SFAC 5 Recording and evaluating in financial

SFAC 6 Elements of financial statements

(used instead of SFAC 3) 1985

The IASB’s Framework

 Issued by IASC (now is IASB) in 1989 under the theoretical framework of international accounting standards

 The previous reports/ disclosures

– IAS 1 (1974): Disclosure in Financial Statements – IASC Building Block Projects (1982-1986)

– IASC Framework Project (1986-1989)

Purposes of Financial Statements

 The role of information users

 Who uses the information?

 Necessary information and levels of supplying

 The standard’s requirements for providing

information

The Accounting Professional (Circle P ) Corporations

(Circle C)

Users

Views of the FASB

 The information users include:

– Investors and creditors;

– Users with the average cautiousness and rational understanding about the economic and business situations.

Views of the IASB

 Includes the following subjects:

– Investors and their advisors;

– Creditors and suppliers;

– Employees and their representatives; – Customers;

– The State and the relevant authorities; – The public.

 The IASB identified a wider range and was not

arranged in order of priority

 The IASB requires financial statements to provide information for the general purpose of the above objects The objects requesting additional

information beyond the scope of the financial statements need to use other information

Necessary information

 Points of the FASB

– Help readers assess the time and the uncertainty of cash flows;

– Provide information about economic resources, obligations and their changes;

– Provide information about the financial results in the period;

– Provide information about that the management has done to complete their duty to the owner;

– Provides information to help managers make decisions for the benefit of owners;

Necessary information

 Points of the FASB

– Provide information about the financial situations, results of operations and financial changes;

– The useful information above is widely used in the financial statements for making decisions;

– Provide information about managers’ management and their responsibilities;

– Additional information.

The balance sheet

Financial situations

 Economic resources

 Financial Structures

 The ability to pay in a

short term and a long term

 The ability to adapt to

changes in the operating environment.

Economic resources, obligations and changes

 Economic resources

 Obligations (liabilities and equity)

 Ability to pay in a short term and a long term.

The balance sheet

Current assets Current Liabilities

THE INCOME STATEMENT

Results of operations

 Mainly focus on the

ability to generate profits.

 Help to assess the

increase of economic resources in the future.

Financial Results

 Help the readers to predict the future financial results

of the company.

The income statement

Sales revenues

Operating expenses

Financial revenues Financial expenses

Other revenues Other expenses

EBT

Operating

income/loss

Other income/loss Financial

income/loss

The cash flow statement

Changes in the financial

situation

 Help to evaluate the

activities in business, finance and investment during the period.

 Help to predict the ability

to create money and the demand for money in the

Timing and risk degree of cash flow

 Evaluate how to create and use money.

 Judging the borrowing and payment situations.

 Evaluating the financial transactions.

 Considering the solvency.

Operating activities

Investment activities

Financial activities

The general cash flow

Selling fixed assets,

Investments

Notes to the financial statement

Additional information

 The additional

information for the balance sheet and the income statement.

 Information about risks

and uncertain situations.

 Additional Information

The explanation

 Help readers understand the financial information.

Notes to the financial statement

•Accounting policies

• Detail information

• Unforeseen liabilities

• Events after the balance sheet date

• Transactions involving important

stakeholders

?

Assumptions and quality features

 Definition

 Views of the FASB

 Views of the IASB

 Being able to provide useful information,

financial statements should be based on assumptions and quality features

 Including the assumptions, accounting principles codified under the interpretation and regulation methods

 Points of FASB

– The quality characteristics

 The basic characteristics

 The minor features

– The basic assumption

– The basic principles

Assumptions and quality features

The basic features of quality

 Suitability

– Accounting information is appropriate when it

is likely to change the users’ decisions To guarantee the appropriateness, the information needs to:

 Have the predicted or assessed values;

Information provided to investors and creditors to make decisions

Only information affecting making decision should be added

Information needs to have the prediction and evaluation

 Reliability

– Accounting information is reliable within the areas where it can be checked when being

presented honestly, without bias or errors

Information is trusty when:

 Being Testable,

The basic features of quality

 Information can be verified when someone

(capable and independent) testing the same evidence, documents or data will give a similar conclusion or result

 Considering the fact that verifiability is the

accurately reflected results and it isn’t the appropriate methods

Honestly presented

 Honestly presenting is the appropriateness

between accounting information and transactions/ events that it wants to present

Being not biased

 Meaning that there is no bias to achieve a desired result or be affected by a point of view or the

individual attitude

 Noting that being not biased does not mean that the information providers do not have their own purposes, but that purposes do not affect the

results

The relationship between liability and

objectivity

 Objectivity is a concept related to the reliable

requirement Objectivity can be understood in the

following ways:

– Not being affected by the measurers;

– Being testable;

– Being an agreement shown by the measurers;

– Having the low dispersing degree when applying a

The research of Ijiri and Jaedicke

 The objective is represented by the following formula: V = 1 / n Σ (ui - u) 2

– n: the number of elements measured

– ui: the value is measured

– U: The average value of the measurement results

 The reliability is represented by the following formula:

 R = 1/n Σ(ui – u*) 2 = 1/n Σ(ui – ū) 2 + 1/n Σ(ū – u*)2

In that formula, u * is the value considered to be true

 Thus, the reliability equals the objective degree plus the bias degree Therefore, the objective is not completely reliable.

 Therefore, evaluating should be considered in order to achieve reasonable results between objective and reliable

The research of Ijiri and Jaedicke

The secondary features of quality

 The ability to compare

– Accounting information must be measured and reported in accordance with a method that can be compared between different enterprises.

 The consistence

– Accounting information is considered to be consistent when companies apply the same method for similar transactions over the accounting periods.

The basic assumption

 Economic entity assumption

 Going concern assumption

 Monetary unit assumption

 Time period assumption

Economic unit assumption

 Economic activities of an entity is collected and reported on the basis of the assumption that this entity is different and separated from the owner and other businesses

 There are two approaches: Under the user’s

control and under the user’s attention

 The concept of the economic entity is broader

Going concern assumption

 In the case that there is the absence of opposite evidence,

a business will be assumed to maintain its existence in an indefinite time.

 The suitability of historical cost depends on the

assumption of continuous operation In addition, this assumption is considered as the basis for asset

depreciation.

 This is an assumption with much disagreement in terms of

Monetary unit assumption

 Economic activities of a unit are measured in a

unit of currency This monetary unit is assumed to

be stable about purchasing capability over the years

 This assumption has much disagreement

concerning the limitations of the currency in achieving the financial statement’s goals

Time period assumption

 An economic entity’s life can be divided into periods for the purposes of providing periodic reports on the business’s operation

The basic principles

 The historical cost principle

 The revenue recognition principle

 The matching principle

 The full disclosure principle

The historical cost principle

 The cost paid to acquire assets is the testable and objective basis in the business’s calculation of

assets and liabilities

 This principle is protected by the assumption of going concern and the monetary principles

although there are debates in the theory and practice around the use of historical cost

The revenue recognition principle

 Revenue is recognized when the consuming

process has actually been completed and an exchanging transaction took place Commonly, this occurs when a sale transaction for an

individual or an independent unit has been certified The confirmation is usually

accomplished through the transfer of the ownership in an exchange business transaction

The matching principle

 Accountants must ensure that when the sales

transactions are made, costs are calculated to be commensurate with revenue

 The use of accrual accounting will support

accountants to allocate revenues and expenses properly in the accounting periods to constitute the business’s life

Time

payment

Time of collection

Time Consuming

The full disclosure principle

 When preparing financial statements, we should provide sufficient information to allow readers (knowledgeable) to make a judgment under the financial conditions of the business

The cost – profit relationship

 Benefits derived from the provision of

accounting information must be more than the cost paid for providing that information

 In the application of accounting principles, some

of them compared to revenues and expenses, assets and liabilities are properly considered to be less important due to the amount of money of net profit

 Identifying whether or not a datum is important when being compared to others which are matters

of judgment and profession

Job features

 The basic accounting theories can not

equivalently be applied in every field

 The suitable presentation of a particular field’s financial situations and operating results may require an escape from the accounting theories due to the specific characteristics of an event or a common practice only existing in this field

 In an unclear situation, the accountant must

choose a plan in which assets and incomes are least inflated

 The caution is only applied in unclear situations The deliberate lowering of assets and profits are not accepted in accounting

The assumptions and quality features

 The IASB’s point of views

– The basic assumptions – The quality features

The accrual basis

 To satisfy the aimed objectives, financial

statements must be prepared on the accrual basis

On this basis, the effects of transactions and events are recognized when they took place (not

at the time receiving or spending money) and were recorded and reported in the period in which they are associated

The going concern basis

 The financial statements are prepared on the basis of the assumption that the business is operating and will

continue to operate, that is not or does not have to be dissolved or shrink in a certain time.

 When this assumption is violated, the financial statements have to be prepared on a different basis and it must be

declared on the financial statements.

The quality features

 Understandability

 Relevance

 Reliability

 Comparability

•The reader is assumed to have a certain knowledge of economics, business, and accounting, have efforts and be willing to read financial statements

• However, the information about a complex issue

which is necessary for making decisions is definitely not excluded from the financial statements for the simple

• The relevance includes predictions and validation;

two characteristics are interrelated

 The appropriateness of the information depends on the

content and materiality.

 Information is called essential when discrepancies or

omissions of it may influence the decisions of users’ financial statements.

 Materiality depends on the amount of money and the

information or errors or evaluations in specific circumstances.

 Reliability means that there is no importance and biased errors and it honestly reflects issues

necessary to be presented

 Information may be appropriate but unreliable

 Reliability includes requirements: the honest

presentation, the content is more important than the form, not being biased, careful and completed

Honestly Presenting

 Information is reliable when it faithfully reflects the events and transactions needed or may be

presented

The content is more important than the form

 To reflect honesty, the information must be

presented in accordance with the economic nature, not only based on the legal form

Not being biased

 To be reliable and not biased Information is

biased if the selection and presentation of financial statements aim to influence the decision making in a predetermined outcome