Developing FASB’s Conceptual Framework: 4 Components

The following points highlight the four major components of Financial Accounting Standards Board (FASB) in developing conceptual framework. The components are: 1. The Objectives of Financial Reporting 2. The Qualities of Useful Information 3. Elements of Financial Statements 4. Recognition and Measurement.

US's FASB Conceptual Framework

1. The Objectives of Financial Reporting:

The FASB’s first Statement of Financial Accounting Concepts (SFAC 1) (1978) identified the broad objectives of financial reporting. The first and most general objective stated in SFAC 1 is to “provide information that is useful to present and potential investors and creditors and other users in making rational investment, credit, and similar decisions.”

ADVERTISEMENTS:

From this beginning point in SFAC 1, the Board expressed other more specific objectives.

These objectives recognize:

(i) That financial reporting should help users predict future cash flows, and

(ii) That information about a company’s resources and obligations is useful in making such predictions.

All the concepts in the conceptual framework are intended to be consistent with these general objectives. In USA, present accounting practice already provides information about a company’s resources and obligations. Thus, although the conceptual framework is intended to be prescriptive of new and improved practices, the concepts in the framework are also descriptive of many current practices.

2. The Qualities of Useful Information:

ADVERTISEMENTS:

The next component in the conceptual framework is the qualities (or qualitative characteristics) that financial information should have if it is to be useful in decision making. In SFAC 2, the FASB said that information is useful if it is (i) relevant, (ii) reliable, and (iii) comparable. Information is relevant if it can make difference in a decision. Information has this quality when it helps users predict the future or evaluate the past and is received in time to affect their decisions.

Information is reliable if users can depend on it to be free from bias and error. Reliable information is verifiable-and faithfully represents what is supposed to be described. In addition, users can depend on information only if it is neutral. This means that the rules used to produce information should not be designed to lead users to accept or reject any specific decision alternative.

Information is comparable if users can use it to identify differences and similarities between companies. Comparability is possible only if companies follow uniform practices. However, even if all companies uniformly follow the same practices, comparable reports do not result if the practices are not appropriate. For example, comparable information would not be provided if all companies were to ignore the useful lives of their assets and depreciate all assets over two years.

Comparability also requires consistency, which means that a company should not change its accounting practices unless the change is justified as a reporting improvement. Another important concept discussed in SFAC 2 is materiality.

3. Elements of Financial Statements:

ADVERTISEMENTS:

Another important step in developing a conceptual framework is to determine the elements of financial statements. This involves defining the categories of information that should be contained in financial reports. The FASB’s discussion of financial statement elements includes definitions of important elements such as assets, liabilities, equity, revenues, expenses, gains, and losses.

The FASB’s pronouncement on financial statement elements was first published in 1980 as SFAC 3. In 1985, SFAC 3 was replaced by SFAC 6, which modified the discussion of financial statement elements to include several elements for not for-profit accounting entities.

4. Recognition and Measurement:

In SFAC 5, “Recognition and Measurement in Financial Statements of Business Enterprises,” the FASB established concepts for deciding (1) when items should be presented (or recognized) in the financial statements, and (2) how to assign numbers to (or measure) those items.

In general, the FASB has said that items should be recognized in the financial statements if they meet the following criteria:

ADVERTISEMENTS:

(i) Definitions — the item meets the definition of an element of financial statements;

(ii) Measurability — it has a relevant attribute measurable with sufficient reliability;

(iii) Relevance — the information about it is capable of making a difference in user decisions; and

(iv) Reliability— the information is representationally faithful, verifiable, and neutral.

In SFAC 5, the FASB has stated that a full set of financial statements should show:

(i) Financial position at the end of the period.

(ii) Earnings for the period.

(iii) Comprehensive income for the period. (This new concept is broader than earnings and includes all changes in owners’ equity other than those that resulted from transactions with the owners. Some changes in asset values are included in this concept but are excluded from earnings).

(iv) Cash flows during the period.

(v) Investments by and distributions to owners during the period.

, ,


Related pages


how to find ledger folio number on chequeconcept of activity based costinghow to prepare trial balance from ledgermarginal cost and marginal costingmarginal cost per unit formulawhat is the meaning of divisiblechange in accounting estimate disclosure examplebudgeting and forecasting meaningusefulness of ratio analysiswhat is materiality principleprofitability ratios accountingoffshore financial centresthree major theories of dividend policyintroduction of debenturecash receipt book formataccounting for sinking fundcreditors turnover ratio formulaspontaneous financing examplesbep formula in unitsmodes of winding up a companybop definition economicswhat are short term marketable securitiesannuity method of valuation of goodwillimportance of flexible budgetvariance analysis and standard costingselling accounts receivable to obtain short term fundsprinciples of accounting conceptsmrtp companiesspecial journals accountinghow to allot sharesongc balance sheetfinding ebitelements of the accounting equationcost volume profit analysis formulaslifecycle costingcapital gearing ratio meaningsemi variable expensesdisadvantages of kaizen costingaccounting ratios and formulasdebenture payablecontribution to sales ratiodebt securitisation processmodigliani miller proposition 2capitalisation definitionmargin of safety formula percentageeffects of deficit financing on indian economydefine budgetedmarginal costing as a tool for decision makingfloatation formulaarticles on target costingwhat is a liquid asset exampleshorizontal equity in taxationindustrial financial institutionsvalu engineeringabsorption costing income statement exampleerrors not affecting the trial balanceimportance of horizontal analysischaracteristics of process costingpromissory note problemsmarginal costing in accountinguses of cost volume profit analysisthree column ledgercharacteristic of managerial accountingmeaning of redemption of debenturesdifference between tax avoidance and tax evasiondefine petty cash bookwhat does the word dividend meandisadvantage of break even analysisaccounting objectivity principleincome & expenditure accountvertical fiscal imbalance definitioncompleted contract method examplesubsidiary means in hindiprocedure for preparing bank reconciliation statementcost accounting sumspurchase method of accounting for mergersdisadvantages of financial statement analysis