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CONCEPTUAL FRAMEWORK OF ACCOUNTING

Generally accepted accounting principles are a set of standards and rules that are recognized as a general guide for financial reporting. Generally accepted means that these principles must have substantial authoritative support. This support usually comes from the Financial Accounting Standards Board (FASB) and Securities and Exchange Commission (SEC). The FASB has the responsibility for developing accounting principles in the United States.
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FASBS CONCEPTUAL FRAMEWORK


The conceptual framework developed by the FASB serves as the basis for resolving accounting and reporting problems. The conceptual framework consists of: 1 objectives of financial reporting; 2 qualitative characteristics of accounting information; 3 elements of financial statements; and 4 Operating guidelines (assumptions, principles, and constraints).
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OBJECTIVES OF FINANCIAL REPORTING The FASB concluded that the objectives of financial reporting are to provide information that: 1 Is useful to those making investment and credit decisions. 2 Is helpful in assessing future cash flows. 3 Identifies the economic resources (assets), the claims to those resources (liabilities), and the changes in those resources and claims.

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QUALITATIVE CHARACTERISTICS OF ACCOUNTING INFORMATION


The FASB concluded that the overriding criterion for accounting choices is decision usefulness. To be useful, information should possess the following qualitative characteristics: 1 relevance 2 reliability 3 comparability 4 consistency

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RELEVANCE
Accounting information has relevance if it makes a difference in a decision. Relevant information helps users forecast future events (predictive value), or it confirms or corrects prior expectations (feedback value). Information must be available to decision makers before it loses its capacity to influence their decisions (timeliness).
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RELIABILITY
Reliability of information means that the information is free of error and bias. In short, it can be depended on. To be reliable, accounting information must be verifiable we must be able to prove that it is free of error and bias. The information must be a faithful representation of what it purports to be it must be factual.
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COMPARABILITY AND CONSISTENCY


Comparability means that the information should be comparable with accounting information about other enterprises. Consistency means that the same accounting principles and methods should be used from year to year within a company.

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QUALITATIVE CHARACTERISTICS OF ACCOUNTING INFORMATION

Useful Financial Information has:

Relevance
1 Predictive value 2 Feedback value 3 Timely

Reliability
1 Verifiable 2 Faithful representation 3 Neutral

Comparability
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Consistency

THE OPERATING GUIDELINES OF ACCOUNTING


Operating guidelines are classified as assumptions, principles, and constraints.
Assumptions provide a foundation for the accounting process. Principles indicate how transactions and other economic events should be recorded. Constraints on the accounting process allow for a relaxation of the principles under certain circumstances.
Assumptions
Monetary unit Economic entity Time period Going concern
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Principals
Revenue recognition Matching Full disclosure Cost

Constraints
Materiality Conservatism

ASSUMPTIONS
1 The monetary unit assumption states that only transaction data that can be expressed in terms of money be included in the accounting records. Example: employee satisfaction and percent of international employees are not transactions that should be included in the financial records.
Customer Satisfaction Percentage of International Employees
Should be included in accounting records
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Salaries paid

ASSUMPTIONS
2 The economic entity assumption states that the activities of the entity be kept separate and distinct from the activities of the owner of all other economic entities. Example: BMW activities can be distinguished from those of other car manufacturers such as Mercedes.

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ASSUMPTIONS
3 The time period assumption states that the economic life of a business can be divided into artificial time periods. Example: months, quarters, and years
2000
QTR 1 QTR 2 QTR 3 QTR 4 JAN APR JUL OCT

2001
FEB MAY AUG NOV MAR JUN SEPT DEC

2002

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GOING CONCERN ASSUMPTION


4 The going concern assumption assumes that the enterprise will continue in operation long enough to carry out its existing objectives. Implications: depreciation and amortization are used, plant assets recorded at cost instead of liquidation value, items are labeled as fixed or long-term.

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PRINCIPLES
REVENUE RECOGNITION

The revenue recognition principle dictates that revenue should be recognized in the accounting period in which it is earned. When a sale is involved, revenue is recognized at the point of sale.

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PRINCIPLES
MATCHING (EXPENSE RECOGNITION)

Expense recognition is traditionally tied to revenue recognition. This practice referred to as the matching principle dictates that expenses be matched with revenues in the period in which efforts are made to generate revenues. To understand the various approaches for matching expenses and revenues on the income statement, it is necessary to examine the nature of expenses. 1 Expired costs are costs that will generate revenues only in the current period and are therefore reported as operating expenses on the income statement. 2 Unexpired costs are costs that will generate revenues in future accounting periods and are recognized as assets.
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PRINCIPLES
DISCLOSURE

FULL

The full disclosure principle requires that circumstances and events that make a difference to financial statement users be disclosed. Compliance with the full disclosure principle is accomplished through 1 the data in the financial statements and 2 the notes that accompany the statements. A summary of significant accounting policies is usually the first note to the financial statements.
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PRINCIPLES
COST
The cost principle dictates that assets be recorded at their cost. Cost is used because it is both relevant and reliable. 1 Cost is relevant because it represents a) the price paid, b) the assets sacrificed, or c) the commitment made at the date of acquisition. 2 Cost is reliable because it is a) objectively measurable, b) factual, and c) verifiable.
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BASIC PRINCIPLES USED IN ACCOUNTING


Revenue Recognition
Costs At end of production At point of sale

Matching
Matching Sales Revenue

Materials

During production

At time cash received

Labor

Operating Expenses

Revenue should be recognized in the accounting period in which it is earned (generally at point of sale).

Delivery

Advertising

Utilities

Expenses should be matched with revenues

Cost

Full Disclosure
* Financial Statements * Balance Sheet * Income Statement * Retained Earnings Statement * Cash Flow Statement

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Assets should be recorded at cost.

Circumstances and events that make a difference to financial statement users should be disclosed.

CONSTRAINTS IN ACCOUNTING
Constraints permit a company to modify generally accepted accounting principles without reducing the usefulness of the reported information. The constraints are materiality and conservatism. 1 Materiality relates to an items impact on a firms overall financial condition and operations. 2 The conservatism constraint dictates that when in doubt, choose the method that will be the least likely to overstate assets and income.
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CONSTRAINTS IN ACCOUNTING
Materiality Conservatism

$
$
$

$ $

$
$

If dollar amounts of costs are small, GAAP does not have to be followed.
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When in doubt, choose the solution that will be least likely to overstate assets and income.

CONCEPTUAL FRAMEWORK

Objectives of Financial Reporting


Qualitative Characteristics of Accounting Information

Elements of Financial Statements

Operating Guidelines Assumptions


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Principles

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