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Chapter 2: Question 1Q (page 61)

What is a conceptual framework? Why is a conceptual framework necessary in financial accounting?

Short Answer

Expert verified

A conceptual framework is a framework consisting of ideas and objectives that result in the creation of a consistent set of rules and standards.

A conceptual framework is essential in accounting because it specifies the nature, function, and limits of financial accounting and financial statements.

Step by step solution

01

Definition of Conceptual Framework

The conceptual framework can be defined as an instrument that is used to assemble, examine and translate information in an orderly and logical manner.

Its purpose is to make conceptual distinctions and collect different ideas. Strong conceptual framework results in the actual realization of the planned objective. It assists in knowing the future cash flows. It is also beneficial to those who make decisions related to credit and investment.

02

Necessity of conceptual framework in financial accounting

The importance of a conceptual framework in financial accounting is to check whether the financial statements are free from any bias or not and also assist the users by providing useful information required in their decision making.

It is a framework for establishing accounting standards, a source for resolving accounting disputes if any. The conceptual framework is useful for investors as it provides them with the risk capital, and the advisor is concerned about the risk that is included with their investment.

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Most popular questions from this chapter

Question: (Qualitative Characteristics) Recently, your uncle, Carlos Beltran, who knows that you always have your eye out for a profitable investment, has discussed the possibility of your purchasing some corporate bonds. He suggests that you may wish to get in on the 鈥済round floor鈥� of this deal. The bonds being issued by Neville Corp. are 10-year debentures which promise a 40% rate of return. Neville manufactures novelty/party items.

You have told Uncle Carlos that, unless you can take a look at Neville鈥檚 financial statements, you would not feel comfortable about such an investment. Believing that this is the chance of a lifetime, Uncle Carlos has procured a copy of Neville鈥檚 most recent, unaudited financial statements which are a year old. These statements were prepared by Mrs. Andy Neville. You peruse these statements, and they are quite impressive. The balance sheet showed a debt-to-equity ratio of 0.10 and, for the year shown, the company reported net income of $2,424,240.

The financial statements are not shown in comparison with amounts from other years. In addition, no significant note disclosures about inventory valuation, depreciation methods, loan agreements, etc. are available.

Instructions

Write a letter to Uncle Carlos explaining why it would be unwise to base an investment decision on the financial statements that he has provided to you. Be sure to explain why these financial statements are neither relevant nor representationally faithful.

Identify which basic assumption of accounting is best described in each item below.

a)The economic activities of FedEx Corporation are divided into 12-month periods for the purpose of issuing annual reports.

b)Solectron Corporation, Inc. does not adjust amounts in its financial statements for the effects of inflation.

c)Walgreen Co. reports current and non-current classifications in its balance sheet.

d)The economic activities of General Electric and its subsidiaries are merged for accounting and reporting purposes.

Revenues, gains, and investments by owners are all increasing in net assets. What are the distinctions among them?

Expenses, losses, and distributions to owners are all decreases in net assets. What are the distinctions among them?

Accounting information provides useful information about business transactions and events. Those who provide and use financial reports must often select and evaluate accounting alternatives. The FASB statement on qualitative characteristics of accounting information examines the characteristics of accounting information that make it useful for decision-making. It also points out that various limitations inherent in the measurement and reporting process may necessitate trade-offs or sacrifices among the characteristics of useful information.

Instructions

a) Describe briefly the following characteristics of useful accounting information.

1. Relevance (4) Comparability

2. Faithful representation (5) Consistency

3. Understandability

b)For each of the following pairs of information characteristics, give an example of a situation in which one of the characteristics may be sacrificed in return for a gain in the other.

1. Relevance and faithful representation.

2. Relevance and consistency.

3. Comparability and consistency.

4. Relevance and understandability.

c) What criterion should be used to evaluate trade-offs between information characteristics?

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