Pragyani S Maharjan

12/8/15
Accounting 507 Text Chapter 2 Conceptual Framework
Basic Questions:
1. What is a conceptual framework?
Ans: The conceptual framework is a body of interrelated objectives and fundamentals. The
objectives identify the goals and purposes of financial reporting and the fundamentals are the
underlying concepts that help achieve those objectives. Those concepts provide guidance in
selecting the transactions, events and circumstances to be accounted for, how they should be
recognized and measured and how they should be summarized and reported.
2. Should a conceptual framework lay the ground work for rules or explain existing
practice?
Ans: Yes a conceptual framework should lay the ground work for rules or explain the existing
practices. Conceptual framework does not make any changes to the existing practices but do
suggest about how to make it better. The framework influence in the development of new
accounting standards. As the purpose of financial reporting is to provide useful information as a
basis for economic decision making, a conceptual framework will form a theoretical basis for
determining how transactions should be measured (historical value or current value) and reported
i.e. how they are presented or communicated to users.
3. What is the objective of a set of financial statements?
Ans: The objective of financial statements is to provide information in such a manner that
portrays a cohesive financial picture of an entity which can be useful to a wide range of users in
making economic decisions.
4. Who is the audience?
Ans: The audience may be existing and potential investors, lenders and other creditors. They are
the primary users to whom general purpose financial reports are directed. Other parties, such as
regulators and members of the public can be considered as audience as well.
5. Have the objectives or audience changed over time?
Ans: The objectives have not changed but there are contradicting views on the objectives. Some
believe that accountability should be the primary objective whereas others argue that prediction
of future cash flows is more important.
The type of audience has remained the same but the numbers are changed occasionally.

6. What is the FASBs Conceptual Framework Project (CFP)?

Ans: The Conceptual Framework Project (CFP) represents an attempt by the FASB to
develop concepts useful in guiding the Board in establishing standards and in providing a
frame of reference for resolving accounting issues.

7. What is the Joint FASB/IASB Project?

And: Joint FASB/IASB project is the project that FASB and IASB have agreed to conduct
simultaneously in a coordinated manner. The project focuses particularly on revenue recognition,
leasing, insurance contracts, the presentation of other comprehensive income, fair value
measurement, and consolidation of investment companies. One of their joint project was to
develop an improved conceptual framework for International Financial Reporting Standards
(IFRs) and US Generally Accepted Principles which they completed on 2010.

8. What is the state of that project?

The FASB's Conceptual Framework Project (CFP)

SFAC
#1

Title

State

Objectives of Reporting by Business Enterprises

Superseded

#2

Qualitative Characteristics of Accounting Information

Superseded

#3

Elements of Financial Statements of Business Enterprises

Superseded

#4

Objectives of Financial Reporting by Nonbusiness Organizations

Not
discussed

#5

Recognition and Measurement in Financial Statements of Business Enterprises

active

#6

Elements of Financial Statements

Replaced 3

#7

Using Cash Flow Information and Present Value in Accounting Measurement

active

#8

Conceptual Framework for Financial Reporting

Replaced
1, 2 and 3

9. How does the CFP affect practice?

Ans: The CFP do not affect practice directly. The framework do not require a change in GAAP;
amend, modify, or interpret existing accounting or disclosure standards; require changes in
accounting procedures; or require disclosure of practices that might be in conflict with the
concepts. The framework affects practice only by means of its influence in the development of
new accounting standards.

10. Is the CFP GAAP?

Ans: No CFP is not a part of GAAP.
11. Figure 2-1, page 48
Ans: The conceptual framework contains three levels. The first level identifies the objective of
financial reporting i.e. the purpose of financial reporting. The second level outlines the
fundamentals, which are the qualitative characteristics that make accounting information useful,
and the elements of financial statements like revenue, expenses, gains and losses, assets,
liabilities and equities. The third level identifies the implementation guidelines of recognition,
measurement, and disclosure used in establishing and applying accounting standards, and the
specific concepts to put into practice the objective.
12. SFAC #8, Chapter 1, page 49
Ans: Chapter 1 of SFAC No. 8 states that the objective of general-purpose financial reporting is
to provide financial information about the reporting entity that is useful to current and potential
equity investors, lenders, and other creditors in making decisions about providing resources to
the entity.

13. SFAC #8, Chapter 2, pages 50-51, Figure 2.2

Ans: The figure 2.2 shows us the hierarchy of characteristics that an accounting information
possess which helps to distinguish better or more useful information from inferior or less useful
information for decision making purposes. The diagram shows two fundamental qualities that
make accounting information useful for decision making and they are relevance and faithful
representation. Relevant financial information is capable of making a difference in the decisions
made by users. The two main aspects of relevance are predictive value and confirmatory value
(or feedback value). Financial information that faithfully represents a particular transaction or
event will depict the economic substance of the underlying transaction or event which is not
necessarily the same as its legal form. A perfectly faithful representation has three
characteristics: completeness, neutrality, and free from error. Comparability, verifiability,
timeliness, and understandability are the qualitative characteristics that enhance the usefulness of
information that is relevant and faithfully represented. Comparability is the qualitative
characteristic that enables users to identify and understand similarities in, and differences among,
items. Consistency refers to the use of the same methods for the same items, either from period
to period within a reporting entity or in a single period across entities. Verifiability helps assure
users that information faithfully represents the economic phenomena it purports to represent.
Timeliness means having information available to decision makers in time to be capable of
influencing their decisions and finally, Understandability involves classifying, characterizing,
and presenting information clearly and concisely.

14. Cost benefit constraint?

Ans. FASB tells us about the cost benefit constraint i.e. the commitment to setting an accounting
standard only when the benefits of the standard exceeds the costs of that standard to
all stakeholders. This constraint is supposed to take precedence over other concerns, such as
neutrality (freedom from bias) of account information. It is a constraint every accountant should
use and reflect upon the costs of providing explicit information which then should be measured
against the benefits in order to control reporting costs.
15. Relevance and Faithful Representation?
According to the IASB Conceptual Framework- Relevant financial information is capable of
making a difference in the decisions made by users. Information may be capable of making a
difference in a decision even if some users choose not to take advantage of it or are already
aware of it from other sources. There are two main aspects to relevance are predictive value
and confirmatory value (or feedback value).
The financial information should be faithfully represented. A perfectly faithful representation
has three characteristics: completeness, neutrality, and free from error. Although perfection is
difficult or even impossible to achieve, the objective is to maximize those qualities to the
extent possible.

16. Materiality?
Ans: Materiality is an entity-specific aspect of relevance based on the nature or magnitude or
both of the items to which the information relates in the context of an individual entitys financial
report.

17. What is comprehensive income?

Ans: Comprehensive income is a statement of all income and expenses recognized during that
period. The statement includes revenue, finance costs, tax expenses, discontinued operations,
profit share and profit/loss.

18. What are the differences between the capital maintenance and accounting transaction
approaches?

Ans: Under the capital maintenance approach, net income is defined as the maximum amount of
a firms resources that can be distributed to owners during a given period (exclusive of new
owner investments) and still leave the business enterprise as well off at the end of that period as
it was in the beginning.
Under the accounting transaction approach, accounting income is based on the actual
transactions entered into by the firm; primarily revenues arising from the sales of goods or
services minus the costs necessary to achieve these sales.
19. As per SFAC #5, a full set of financial statements should include?
Ans: As per SFAC #5, a full set of financial statements should include
1.
2.
3.
4.
5.

Financial position at the end of the period

Earnings for the period
Comprehensive income for the period
Cash flows during the period
Investments by and distribution to owners during the period

20. What are the differences between earnings and comprehensive income?
Ans: Earnings are a measure of entity performance during a period. This value measures the
extent to which asset inflows (revenues and gains) exceed asset outflows. The concept of
earnings provided in SFAC No. 5 is similar to net income for a period determined under the
transactions approach.
SFAC No. 5 defined comprehensive income as a broad measure of the effects of transactions and
other events on an entity. It comprises all recognized changes in equity of the entity during a
period from transactions except those resulting from investments by owners and distributions to
owners.

21. What are the differences between a rules based approach and a principles based approach
to accounting issues?
Ans: Rule based approach and principles based approach can be differentiated
through the example of goodwill. Under rules-based approach, Goodwill is to be
amortized over a 40 year life until it is fully amortized. This requirement leaves
no room for judgment or disagreement about the amount of amortization expense
to be recognized. Comparability and consistency across firms and through time is
virtually assured under such a rule. However, the requirement lacks relevance

because it does not reflect the underlying economics of the reporting entity, which
differ across firms and through time.
On the contrary, under principles-based approach, Goodwill is not amortized. Any
recorded goodwill is to be tested for impairment and if impaired, written down to
its current fair value on an annual basis. This requirement necessitates the
application of judgment and expertise by both managers and auditors. The goal is
to record the economic deterioration of the asset, goodwill

22. What are the advantages/disadvantages of these approaches?

Ans: Many accountants favor the prospect of using rules-based standards, because in the absence
of rules they could be brought to court if their judgments of the financial statements were
incorrect. When there are strict rules that need to be followed, the possibility of lawsuits is
diminished. Having a set of rules can increase accuracy and reduce the ambiguity that can trigger
aggressive reporting decisions by management.
On the contrary, the fundamental advantage of principles-based accounting is that its broad
guidelines can be practical for a variety of circumstances. Precise requirements can sometimes
compel managers to manipulate the statements to fit what is compulsory. The problem with
principles-based guidelines is that lack of guidelines can produce unreliable and inconsistent
information that makes it difficult to compare one organization to another.
23. How would you define US GAAP?
Ans: US GAAP, are the generally accepted accounting principles adopted by the U.S. Securities
and Exchange Commission (SEC).