Conceptual Framework
- Important because it has many purposes.
- It is not an accounting standard.
- If CF and AS have a conflict, AS prevails over the CF.
- Assist the International Accounting Standards Board to develop standards that
are based on consistent concepts.
- Assist preparers to develop consistent accounting policies when no standard
applies to a particular transaction; and
- Assist all parties to understand and interpret the standards.
Hierarchy of Accounting Qualities
- We need to determine the benefits before we adapt it (Cost Constraint)
- Benefits > Cost of implementing or adapting something.
- To have relevance, accounting information must be capable of making difference
in a decision.
- Information with no bearing (to have an influence on something) on a decision is
not relevant.
- Financial information can make a difference when it has predictive value,
confirmatory value, or both.
- Predictive value – if it has value as an input to predictive processes used by
investors to form their own expectations about the future.
Example:
If potential investors are interested in purchasing common shares in a particular
business, they may analyze its current resources and claim to those resources.
Its dividends payments or its past income. To predict the amount timing and
uncertainty of the business’ cash flows.
- Confirmatory value – relevant information also helps users confirm or correct
prior expectations.
Example:
When a particular company issues its year end financial statements, it confirms
or changes past or present expectations based on previous evaluations.
- It follows that predictive value and confirmatory value are interrelated.
- Materiality – company’s specific aspect of relevance. Information is material if
omitting or misstating it would influence decisions that users make based on the
reported financial information. Information is immaterial, not significant if omitting
or misstating it does not influence the decisions of the users of the FS. So, it is
relative.
Example:
It is not an absolute amount; it is relative.
In a sari-sari store, 10,000 might be material but when it comes to multi-national
company, perhaps 10,000 is not that material.
- Faithful Representation means that the number and descriptions match what
really existed or happened. It is a necessity because most users have ___ the
time nor the expertise to evaluate the factual content of the information.
- Completeness – all information that is necessary for faithful representation is
provided. An omission can cause information to be false or misleading and does
not being helpful to the users of financial reports.
Example:
There is an existing law so we should report it. An omission (act of leaving
something out) of that can cause misleading information.
- Neutrality – you are not taking sides. It means that the company cannot select
information to favor one set of interested parties over another.
Example:
The business is applying for a bank loan. For the business to secure the approval
of the bank, the accountant should not prepare the financial statements in favor
of the employer. The accountant should be neutral. Unbiased information.
- Free from error – the information item free from error will be more accurate
faithful representation of a financial item. **Sometimes it is not a hundred percent
accurate because in accounting we do the estimate. Estimates are allowed
provided that the amount is not too high or too low. Fair presentation of
accounting information.
- Comparability – information that is issued and reported in a similar manner for
different companies is considered comparable. It enables users to identify the
real similarities and differences and economic events between companies. To
compare it, consistency must be present.
- Consistency – it is present when a company applies the same accounting
treatment to similar events, from period to period. It doesn’t mean that the
company cannot change accounting methods. Changing accounting methods is
still allowed provided that the AM is acceptable by the accounting standards.
- Verifiability – occurs when independent measurers using the same method
obtain the same results it can be verified. Like the concept of objectivity.
Direct verification and indirect verification
- Timeliness – is having information available to the decision makers before it
loses its capacity to influence decision.
Example:
The financial report was due on Friday, but it was submitted the other week. So, it
loses its capacity to influence decisions.
- Understandability – for information to be useful there must be a connection
between these users and the decisions they make. The quality of information that
lets reasonably informed users see its significance.
Accounting Concepts
- Important ideas that accountant assume in recording business transactions.
- Bedrock of accounting and known as postulates or accounting assumptions.
- Examples of AC or Assumptions are:
Separate entity
Going concern
Time period
Accrual
Monetary unit
Accounting Conventions
- Accounting practices that practitioners accept because of their long existence
and use.
Example:
The use of debit and credit card or the dual aspect concept. **The normal
balance of asset is debit, the normal balance of liability is credit, and the normal
balance of equity or capital is credit. Revenues – credit. Expenses – expense.
- Accountants have long observed this practice based on the idea that in every
business transaction, a value received has a corresponding value given.
Basic Assumptions in Accounting
Economic Entity Assumption
- A business enterprise is regarded as separate and distinct entity from the person
or people who own or run it.
Example:
Mr. A is the owner of a barbershop, the personal transactions of Mr. A is separate
from the business transactions. It should not be mixed in the accounting book.
Mr. A has numerous businesses. For each business, a separate accounting
record.
Mr. A bought a car intended for the business. Therefore, you record it on the
accounting books of the business. If Mr. A bought a car for personal use, it should
not be recorded in the books of the business. It should be separate and distinct.
Going Concern Assumption
- Assumes that the business entity will continue operating indefinitely (unspecified
period) for a period sufficient to carry out its contemplated objectives, plans,
contracts, and commitments unless the liquidation of the entity is imminent.
- Related to objectivity and historical cost. There are supporting documents.
Example for historical cost, the business purchase furniture amounting to 40,000
so there’s a supporting document related to that.
Monetary Unit Assumption
- Assumes that money (Php) is the common denominator in measuring economic
activity. In accounting, we are providing primarily financial in nature. So, how to
record a transaction if we don’t know the amount. We assign it.
- Changes in money purchasing power is generally NOT accounted for. We are not
restating the amounts unless there is hyper-inflationary economy. Only if situation
changes dramatically, only inflation accounting is considered.
- Only if circumstances change dramatically that inflation accounting is considered.
Periodicity Assumption
- Assumes that the life of the enterprise is divided into several periods (normally at
equal lengths of time). For example, you want to present it every month then
that’s monthly. Every 3 months, quarterly. And so on. We need to prepare FS at
least yearly or annually.
- When a financial report is prepared, it is important to indicate the date the time
period it covers.
Accrual Basis Assumption
- Financial Statements (such as Balance Sheet (SFP), Income Statement, etc.),
except Statement of Cash Flows, are prepared on the accrual basis of
accounting. We are using cash basis in SCF.
- Net profit is the difference between revenue and expenses, NOT cash inflows
and cash outflows. We record expense if its already incurred, and we are
recording the revenue if its earned. We are not waiting for the actual cash
payment and cash collection. If the revenue are earned, we record it.
Basic Principles of Accounting
- Accounting principles are those that define broadly the actions that will best
accomplish the objectives of accounting.
- Refers to a doctrine, which is the basis of all the rules, procedure, and methods
used in the accounting practice.
- The authoritative body of accountancy formulated standard principles,
assumptions, and procedures that are called Generally Accepted Accounting
Principles (GAAP).
1. Measurement Principle
a. Cost Principle – also known as historical cost, recorded amount is based on
the acquisition price or the purchase price.
b. Fair Value Principle – the valuation principle is market-based.
2. Revenue Recognition Principle – revenues are recognized when earned
regardless of when cash is collected.
Example:
We delivered the goods to customer A; the credit terms are it needs to be paid 30
days after. Although there is no collection yet, we need to recognize the revenue.
3. Expense Recognition Principle – expenses are recognized when incurred
regardless of when cash is paid.
Example:
We have the Meralco bill, we have the electricity consumed already. Although not
yet paid, we need to record the expense.
4. Full-Disclosure Principle – all relevant information should be reported.
**Notes of Financial Statements.
