INTERMEDIATE
ACCOUNTING
Sixth Canadian Edition
KIESO, WEYGANDT, WARFIELD, IRVINE, SILVESTER, YOUNG, WIECEK
Prepared by:
Gabriela H. Schneider, CMA; Grant MacEwan College
CHAPTER
2
Conceptual Framework
Underlying Financial Reporting
Learning Objectives
1. Describe the usefulness of a conceptual
framework.
2. Describe the main components of the
conceptual framework for financial reporting.
3. Understand the objective of financial
reporting.
4. Identify the qualitative characteristics of
accounting information.
Learning Objectives
5. Define the basic elements of financial
statements.
6. Describe the basic assumptions of
accounting.
7. Explain the application of the basic principles
of accounting.
8. Describe the impact that constraints have on
reporting accounting information.
Conceptual Framework Underlying
Financial Reporting
Conceptual
Framework
Rationale
Development
First Level:
Basic
Objectives
Second Level:
Fundamental
Concepts
Third Level:
Recognition and
Measurement
Qualitative
characteristics
Basic
assumptions
Basic Elements
Basic principles
Constraints
Conceptual Framework
• Users of financial statements need relevant
and reliable information
• To provide such information, the profession
has developed a set of principles and
guidelines
• These principles and guidelines are collectively
called the Conceptual Framework
• In short, the Framework is like a constitution
for the profession
Objectives of the Conceptual
Framework
• The Framework is to be the foundation for
building a set of coherent accounting
standards and rules
• The Framework is to be a reference of
basic accounting theory for solving
emerging practical problems of reporting.
• This framework can be illustrated as
follows:
Conceptual Framework for
Financial Reporting
Recognition and Measurement Concepts
3rd Level: Answers the ‘How’ Question
Qualitative
Elements
2nd Level: The ‘Bridge’
Objectives
1st Level: Answers the ‘Why’ Question
Conceptual Framework – Objectives
To provide information:
•useful to those making investment and credit
decisions
•useful in making resource allocation decisions
•useful in assessing management stewardship
•to individuals who reasonably understand
business and economic activities.
Conceptual Framework – Qualitative
Characteristics
•Primary qualities are Relevance
and Reliability of accounting
information
•Secondary qualities are
comparability and consistency of
reported information
Conceptual Framework – Qualitative
Characteristics
• Information is relevant if it:
– has predictive value
– has feedback value
– is timely
• Information is reliable if it:
– is verifiable; independent
users can arrive at the same
conclusion
– is representationally faithful; it
represents (reports) what
actually happened
– is neutral; is free from bias
• Information is comparable if
it:
– allows users to identify real
economic similarities and
differences
• Information is consistent if:
– similar events have the same
accounting treatment from
period to period
– if the treatment changes, full
disclosure is made
Conceptual Framework – Basic
Elements
• Section 1000 of the CICA
Handbook defines seven elements
directly related to the
measurement of performance of
financial status of an enterprise
• These elements can be traced to
Balance Sheet and Income
Statement
Conceptual Framework – Basic
Elements
Balance Sheet
Assets: probable future
economic benefit
Liabilities: probable future
sacrifice of economic benefits
Equity/Net Assets: residual
interest (Assets – Liabilities)
Conceptual Framework – Basic
Elements
Income Statement
Revenues: increases in
economic resources
Expenses: decreases in
economic resources
Gains: increases in equity
Losses: decreases in equity
Conceptual Framework – Recognition
and Measurement Concepts
• Explain which, when, and how
financial elements and events
should be recognized, measured and
reported
• These concepts are categorized as:
• basic assumptions
• principles
• constraints
Conceptual Framework – Recognition
and Measurement Concepts
Basic
Assumptions
Principles of
Accounting
Constraints
1. Economic
entity
2. Going concern
3. Monetary unit
4. Periodicity
1. Historical cost
2. Revenue
recognition
3. Matching
4. Full disclosure
1. Cost Benefit
2. Materiality
3. Industry
practices
4. Conservatism
Basic Assumptions
Economic Entity Assumption
–
–
–
–
–
The economic entity can be identified with a
particular unit of accountability
The business activity is separate and distinct from
its owners
The entity’s assets and other financial elements
are not commingled with those of the owners
The economic entity assumption is an accounting
concept, and not a legal construct
Departments or divisions of an entity may be
considered separate entities
Basic Assumptions
Going Concern Assumption
– The business is assumed to continue indefinitely
unless terminated by owners
– Expectation of continuing long enough to meet their
objectives and commitments
– The basis of recording financial elements is historical
accounting
– If liquidation of the enterprise is assumed to occur,
then liquidation accounting is more appropriate
– Liquidation accounting (net realizable value) is not
followed unless liquidation of the enterprise appears
imminent
Basic Assumptions
Monetary Unit
– Money is the common unit of measure of
economic transactions
– Use of a monetary unit is relevant, and simple and
understandable, universally available, and useful
– The dollar is assumed to remain relatively stable in
value (effects of inflation/deflation are ignored
– Monetary unit is relevant only as long as it is
assumed that quantitative data is the driving force
behind users decision making
Basic Assumptions
Periodicity (Time Period) Assumption
– Economic activity of an entity may be artificially
divided into time periods for reporting purposes
– Shorter time periods are subject to errors but may
be more timely
• Trade-off between relevance and reliability
– Technology, accountability and aware investors are
driving the demand for more on-line, real-time
financial information
Basic Principles of Accounting
Historical Cost Principle
– Assets and liabilities are recorded at acquisition price
– Financial information is reliable (a primary
characteristics of information)
– Recording transactions at other than historical cost
results in a net income materially affected by opinion
– Users of financial statements may find current fair
value information to be useful as well
– A “mixed attribute” system reports historical cost, fair
value, and lower of cost or market values
Basic Principles of Accounting
Revenue Recognition Principle
– Revenue is recognized when it is earned and
the amount can be objectively determined
– Revenue is recognized at the date of sale
(objective test)
• Date of sale provides an objective and verifiable
measure of revenue
• Applicable with a discrete earnings process and one
critical event
Basic Principles of Accounting
– There are exceptions; revenue may be recognized:
1
2
During Production: revenue is recognized prior to contract
completion in certain long-term construction contracts

Considered as a continuous earnings process

Reliable cost and progress estimates must be achieved
End of Production: revenue is recognized end of production
and before sale occurs

3
Sale and price are certain
Receipt of cash: when sales figure cannot be established
due to collection uncertainty

An example - instalment sales contracts (revenue is
recognized only on receipt of cash)
Basic Principles of Accounting
Matching Principle
• Expenses in one period are matched to
revenues recognized in the same period
• There should be a logical, rational association
of revenues and expenses
• If the expense benefits the current and future
periods, it is recorded as an asset
• This asset cost is then systematically and
rationally matched to future revenues
Basic Principles of Accounting
Full Disclosure Principle
• Financial statements must report any information that
could reasonably be seen to affect the judgement or
decision of an informed user
• Disclosure may be made:
– within the main body of the financial statements
– as notes to those statements
– as supplementary information
• Disclosed information should:
– provide sufficient detail of the occurrence; and at the same time
– be sufficiently brief enough to remain understandable
• Full disclosure should not be seen as a replacement for
well-founded accounting practice
Constraints
Cost-Benefit Relationship
– The cost of providing information should not
outweigh the benefit derived
– Costs and benefits are not always obvious or
quantifiable
– Sound judgement must be used in providing
information
Constraints
Materiality
• Refers to an item’s impact on a user’s decision
– An item must make a difference to be material and be disclosed
– It is a matter of the relative significance of the element
– Both quantitative and qualitative factors are to be considered in
determining relative significance
• General rule of thumb: if the item is between 5-10% of net
income it is considered material
• Determination of materiality requires professional
judgement and expertise
Constraints
Industry Practices
• The nature of some industries may
sometimes require departures from basic
accounting theory
• If application of accounting theory results in
statements that are not comparable or
consistent, then industry practices must
examined for possible explanations
Constraints
Conservatism
• When in doubt, choose a conservative
solution
• This solution will be least likely to overstate
assets and income
• Conservatism does not suggest that net
assets or net income be deliberately
understated
– Simply a mechanism to discourage the
overstatement of net income and net assets
Conceptual Framework for Financial Reporting
Recognition and Measurement Concepts
Assumptions
Principles
Constraints
Economic Entity
Going concern
Monetary unit
Periodicity
Historical cost
Revenue
recognition
Matching
Full disclosure
Cost-benefit
Materiality
Industry Practice
Conservatism
Qualitative
Primary:
-Relevance
-Reliability
Secondary:
-Comparability
-Consistency
Elements
Assets
Liabilities
Equity/Net Assets
Revenues
Expenses
Gains and Losses
Objectives
-useful in investment & credit decisions
-useful in making resource allocation decisions
-useful in assessing management stewardship
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