Conceptual Frame Work of Accounting Essay

1. Introduction: Conceptual frameworks (theoretical frameworks) are a type of intermediate theory that attempt to connect to all aspects of inquiry (e. g. , problem definition, purpose, literature review, methodology, data collection and analysis). Conceptual frameworks can act like maps that give coherence to empirical inquiry. Because conceptual frameworks are potentially so close to empirical inquiry, they take different forms depending upon the research question or problem. The Conceptual Framework of Accounting is like a constitution for financial reporting, providing the foundation for standards.

The Conceptual Framework provides structure to the process of creating financial reporting standards and ensures that standards are based on fundamental principles. This helps prevent standards from becoming ad hoc and transitory. Without a framework, accounting standards might be based on the most expedient solution to a particular issue, rather than a solution that is consistent with a unified theory of accounting. The Conceptual Framework is an essential element in the development of principles-based accounting standards.

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The Conceptual Framework makes standards setting more efficient by providing a common set of terms and premises for analyzing accounting issues. Each time a debate on an accounting issue arises, it isn’t necessary to reinvent the wheel. FASB and the IASB expect a common Conceptual Framework to promote the convergence of U. S. GAAP and International Financial Reporting Standards (IFRS), ultimately leading to a single set of high-quality global accounting standards. Additional information regarding the joint conceptual framework project can be found at www. fasb. org and www. iasb. rg. Auditors took the leading role in developing GAAP for business enterprises. 2008, the FASB issued the FASB Accounting Standards Codification, which reorganized the thousands of US GAAP pronouncements into roughly 90 accounting topics. In 2008, the Securities and Exchange Commission issued a preliminary “roadmap” that may lead the U. S. to abandon Generally Accepted Accounting Principles in the future (to be determined in 2011), and to join more than 100 countries around the world instead in using the London-based International Financial Reporting Standards. 2. Objectives

Financial reporting should provide information that is: * Financial reporting should provide information, useful to present to potential investors and creditors and other users in making rational investment, credit, and other financial decisions. * Financial reporting should provide information, helpful to present to potential investors and creditors and other users in assessing the amounts, timing, and uncertainty of prospective cash receipts. * Financial reporting should provide information about economic resources, the claims to those resources, and the changes in them.

The FASB spent considerable time and effort on this project. The board views its conceptual framework as “a constitution, a coherent system of interrelated objectives and fundamentals. ” The FASB’s conceptual framework consists of four items: 1. Objectives of financial reporting 2. Qualitative characteristics of accounting information 3. Elements of financial statements 4. Operating guidelines (assumptions, principles, and constraints) 3. Basic concepts To achieve basic objectives and implement fundamental qualities GAAP has four basic assumptions, four basic principles, and four basic constraints. 3. 1Assumptions

Academic writers on accountancy, and others, have identified many accounting concepts which could be regarded as forming part of the accounting conceptual framework. However, the fundamental accounting concepts are defined in SSAP 2 and are often referred to in later SSAPs. The four concepts are defined in the standard as follows: 3. 1. 1 Business Entity: Business Entity assumes that the business is separate from its owners or other businesses. Revenue and expense should be kept separate from personal expenses. 3. 1. 2 Going Concern: Going Concern assumes that the business will be in operation indefinitely.

This validates the methods of asset capitalization, depreciation, and amortization. Only when liquidation is certain, this assumption is not applicable. 3. 1. 3 Periodicity: The Periodicity or the Time-period principle implies that the economic activities of an enterprise can be divided into artificial time periods. 3. 1. 4 Monetary Unit principle: Monetary Unit Principle assumes a stable currency is going to be the unit of record. The FASB accepts the nominal value of the US Dollar as the monetary unit of record unadjusted for inflation. 3. 1 Principles 3. 2. Cost principle: requires companies to account and report based on acquisition costs rather than fair market value for most assets and liabilities. This principle provides information that is reliable (removing opportunity to provide subjective and potentially biased market values), but not very relevant. Thus there is a trend to use fair values. Most debts and securities are now reported at market values. 3. 2. 2 The Revenue recognition: The Revenue recognition principle is a cornerstone of accrual accounting together with matching principle. They both determine the accounting period, in which revenues and expenses are recognized.

According to the principle, revenues are recognized when they are (1) realized or realizable, and are (2) earned (usually when goods are transferred or services rendered), no matter when cash is received. In cash accounting – in contrast – revenues are recognized when cash is received no matter when goods or services are sold. Cash can be received in an earlier or later period than obligations are met (when goods or services are delivered) and related revenues are recognized that results in the following two types of accounts: * Accrued revenue: Revenue is recognized before cash is received. Deferred revenue: Revenue is recognized after cash is received. 3. 2. 3 Matching principle: Expenses have to be matched with revenues as long as it is reasonable to do so. Expenses are recognized not when the work is performed, or when a product is produced, but when the work or the product actually makes its contribution to revenue. Only if no connection with revenue can be established, cost may be charged as expenses to the current period (e. g. office salaries and other administrative expenses).

This principle allows greater evaluation of actual profitability and performance (shows how much was spent to earn revenue). Depreciation and Cost of Goods Sold are good examples of application of this principle. The matching principle is a culmination of accrual accounting and the revenue recognition principle. They both determine the accounting period, in which revenues and expenses are recognized. According to the principle, expenses are recognized when obligations are (1) incurred (usually when goods are transferred or services rendered, e. . sold), and (2) offset against recognized revenues, which were generated from those expenses (related on the cause-and-effect basis), no matter when cash is paid out. In cash accounting—in contrast—expenses are recognized when cash is paid out, no matter when obligations are incurred through transfer of goods or rendition of services: e. g. , sale. If no cause-and-effect relationship exists (e. g. , a sale is impossible), costs are recognized as expenses in the accounting period they expired: i. e. , when have been used up or consumed (e. g. of spoiled, dated, or substandard goods, or not demanded services). Prepaid expenses are not recognized as expenses, but as assets until one of the qualifying conditions is met resulting in a recognition as expenses. Lastly, if no connection with revenues can be established, costs are recognized immediately as expenses (e. g. , general administrative and research and development costs). Prepaid expenses, such as employee wages or subcontractor fees paid out or promised, are not recognized as expenses (cost of goods sold), but as assets (deferred expenses), until the actual products are sold.

The matching principle allows better evaluation of actual profitability and performance (shows how much was spent to earn revenue), and reduces noise from timing mismatch between when costs are incurred and when revenue is realized. 3. 2. 4 Disclosure principle: Amount and kinds of information disclosed should be decided based on trade-off analysis as a larger amount of information costs more to prepare and use. Information disclosed should be enough to make a judgment while keeping costs reasonable.

Information is presented in the main body of financial statements, in the notes or as supplementary information 3. 2 Constraints 3. 3. 1Objectivity principle: The company financial statements provided by the accountants should be based on objective evidence. 3. 3. 5 Materiality principle: The significance of an item should be considered when it is reported. An item is considered significant when it would affect the decision of a reasonable individual. 3. 3. 6 Consistency principle: It means that the company uses the same accounting principles and methods from year to year. . 3. 7 Prudence principle: When choosing between two solutions, the one that will be least likely to overstate assets and income should be picked. Revenue and profits are not anticipated, but are recognized by inclusion in the profit and loss account only when realised in the form either of cash or of other assets the ultimate cash realization of which can be assessed with reasonable certainty; provisions made for all known liabilities (expenses and losses) whether the amount of these is known with certainty or is a best estimate in the light of the information available”.

SSAP 2 acknowledges that the relative importance of these concepts will vary according to the circumstances of a particular case; however, it is made clear that where the accruals concept is inconsistent with the prudence concept then prudence should take precedence. 4. 1 Conclusion This article has outlined the nature and purpose of a conceptual framework and explained the purpose and scope of the Statement of Principles. Students often overlook this important area of the syllabus which is fundamental to understanding the whole process of preparing financial statements. References 1. Alfredson, K. , K. Leo, R. Picker, P.

Pacter and J. Radford (2005) Applying International Accounting Standards, John Wiley & Sons, Australia. 2. Australian Accounting Standards Board (AASB) (2003) ED 124 Released: The definition of reporting entity, the IASB framework and revenue and government grant standards, Media Release, 1 October. Available at http://aasb. com. au. 3. Australian Accounting Standards Board (AASB) (2004) Concepts and policies Available at http://aasb. com. au/pronouncement/policies. htm. 4. Bradbury, M. (2003) ‘Implications for the conceptual framework arising from accounting for financial instruments’, Abacus, 39(3): 388-397. 5.

Financial Accounting Standards Board (FASB) (2004) ‘FASB response to SEC study on the adoption of a principles-based accounting system’, July 2004. Available at http:// www. fasb. org. 6. International Accounting Standards Board (IASB) (2004) ‘History’. Available at http://www. iasb. org/about/history. asp. 7. International Organization of Securities Commissions (IOSCO) (2000) IASC Standards’, Press release, 17 May 2000. Available at http://www. iosco. org/press/presscomm000517. html. 8. Jones, S. and P. Wolnizer (2003) ‘Harmonization and the conceptual framework: An international perspective’, Abacus, 39(3): 375-387.


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