FA1 Problem: Conceptual Framework of Accounting – General

FA1 Problem: Conceptual Framework of Accounting – General

Accounting involves the collection, summarization and reporting of financial information. Oftenthe preparer of financial statements must use professional judgement to make decisions regardingidentification, measurement and reporting of various financial statement items.The users of financial statements are and their objectives should guide financial reporting. Theseobjectives, together with the consideration of the qualitative characteristics of accountinginformation determine the form and substance of the financial statements.The chart on the following page illustrates the conceptual framework of accounting theory.Preparers of financial statements must relate the framework to the situation and use their  professional judgement to determine the accounting treatment of various financial statementitems.Required:Discuss each of the following statements, with reference to the relevant components of theconceptual framework of accounting theory (see chart on following page).a) The freedom to change from one inventory costing method to another at will permits awide range of possible net income figures for a company over a given period, resulting infinancial statements that are less meaningful. b) Accounting attempts to serve many masters. This is not easy, because the needs of onegroup may conflict with the needs of the others.c) Information that is objective (verifiable) may not be relevant to many decisions, andinformation which is relevant may not be objective (verifiable).d) Issues of revenue and expense recognition should not be viewed in isolation from thoseof asset and liability valuation. They are intrinsically related. Any determination thataffects reported income will affect a related balance sheet account, and vice versa.e) Accounts receivable net of bad debts, and the related revenues are not “accurately” presented, but are “fairly” presented.f) Any public company, whose securities are traded in a public market or that is required tofile financial statements annually with a provincial securities commission, is required todisclose segmented information. Faced with excessive costs to gather and communicateinformation, multinationals and diversified enterprises argue that segmented informationrenders redundant the information contained in consolidated financial statements

A Conceptual Framework of AccountingUser Orientation

Decision maker’s1. Needs2. Characteristics3. Level of knowledge

User Objectives:

1. Performance evaluation(ability to earn income and generate a return on investment)2. Cash Flow prediction(ability to generate cash flows to meet obligations)3. Stewardship

Qualitative Characteristics

1. Primary qualitiesA. Relevance-Predictive value-Feedback value-TimelinessB. Reliability-Verifiability-Representational faithfulness-Neutrality-Conservatism2. Secondary qualitiesA. ComparabilityB. Consistency

Assumptions

1. Economic entity2. Going concern3. Monetary unit4. Periodicity

Principles

1. Historical cost2. Revenue recognition3. Matching4. Full disclosure

Constraints

1. Cost-benefit2. Materiality3. Industry Practice4. Conservatism

Financial Statements