Why conceptual framework necessary in financial accounting

For many of us, accounting appears to be methodical and procedural in nature. The visible portion of accounting — record keeping and preparation of financial statements — too often suggests the application of a low — level skill in an occupation devoted to mundane objectives and devoid of challenge and imagination.

In accounting, a large body of theory conceptual framework does exist, however. It consists of philosophical objectives, normative theories, interrelated concepts, precise definitions, and underlying assumptions, principles, and constraints.

This theoretical foundation may be unknown to many people, but serves to justify accounting as a truly professional discipline. Thus, accountants philosophize, theorize, judge, create, and deliberate as a significant part of their professional activity. The principles of accounting are unlike the principles of the natural sciences and mathematics. An accounting theory is not something that is discovered rather, it is created, developed, or decreed on the basis of environmental factors, intuition, authority, and acceptability because the theoretical framework accounting is difficult to substantiate objectively or by experimentation, arguments concerning it can degenerate into quasi — religious dogmatism.

As a result, the credibility of accounting rests upon its general recognition and acceptance by preparers, auditors, and users of financial statements. Given this, the purpose of this chapter is to examine the nature and usefulness of a conceptual framework for financial accounting, and discuss its components. A conceptual framework is like a constitution. Firs, to be useful, standard setting should build on and relate to an established body of concepts and objectives.

A soundly developed conceptual framework should enable the development and issuance of a coherent set of standards and practices built upon the same foundation. Third, such a framework should enhance comparability among the financial statements of different companies. Similar events should be similarly accounted for and reported; dissimilar events should not be. Fourth, new and emerging practical problems should be solved more quickly by referring to an existing framework of basic theory.

The purpose of the conceptual framework project was to provide a sound and consist basis for the development of financial accounting standards. The expanded conceptual framework project undertaken by the FASB has resulted in the publication of the following relating to financial reporting for business enterprises:.

Statement of Financial Accounting concepts No. SFAC No. Sets forth fundamental recognition and measurement criteria and guidance on. In general, when providing information to users of financial statements, the accounting profession has relied on general-purpose financial statements.

The intent of these is to provide useful information to various user groups at reasonable cost. Underlying these objectives is the presumption that users have a fairly sophisticated understanding of matters related to business and financial accounting. This point is important because it means that when preparing financial statements, accountants may assume that users have a reasonable level of competence; this has an impact on the way and the extent to which information is reported.

Summarizing, the FASB identified eight objectives of financial reporting, all of which focused on providing information needed by current and prospective investors and creditors of a business enterprise in their decision making. The objectives first level are concerned with the goals and purposes of accounting.

Later, we will discuss the ways these goals and purposes are implemented third level. Between these two levels it is necessary to provide certain conceptual building blocks that explain the qualitative characteristics of accounting information and define the elements that financial statements comprise. These conceptual building blocks form bridge between the why the objectives and the how recognition and measurement of accounting. Choosing an acceptable accounting method, the amount and type of information to be disclosed, and the format in which information should be presented involves determining which of several possible alternatives provide the best i.

Financial reporting is concerned, in varying degrees, with decision making by financial statement users. As a consequence, the overriding criterion by which accounting choices can be judged is that of decision usefulness, that is, providing information that is most useful for decision-making. To help distinguish superior more useful form inferior less useful information, the qualitative characteristics, which make information useful, should be considered. Decision makers vary widely in the types of decisions they make, the methods of decision making they employ, the information they already possess or can obtain from other sources, and their ability to process the information.

Consequently, for information to be useful there must be a connection linkage between it and the users and the decisions they make.

This linkage is the understandability of the information. It is generally agreed that relevance and reliability are two primary qualities that make accounting information useful for decision making.

Each of these qualities is achieved to the extent that information incorporates specific capabilities ingredients. Relevance is the capacity of accounting information to make a difference to the external decision makers who use financial reports.

If certain information is disregarded because it is perceived to have no bearing on a decision, it is irrelevant to that decision.

Reliability means that users can depend on accounting information to represent the underlying economic conditions or events that it purports to represent. Reliability of information is a necessity for individuals who have neither the time nor the expertise to evaluate the factual content of financial statements. It is especially important to the independent audit process.

Like relevance, reliability must meet three qualitative criteria. The potential use of different acceptable methods by one enterprise in different years, or by different companies in a given year, would make comparison of financial results difficult consequently, in order to enhance the usefulness of accounting reports, the qualities of comparability and consistency are components of the conceptual framework.

They are considered to be secondary in our hierarchy to the qualities of relevance and reliability. If information is to be useful, it must first be relevant and reliable, but achieving these primary qualities may require foregoing the secondary qualities. Ideally, financial accounting information would satisfy both qualitative levels. FASB's Conceptual Framework, a project begun in to develop a sound theoretical basis for the development of accounting standards in the United States.

From to the FASB released eight concept statements. With a sound conceptual framework in place the FASB is able to issue consistent and useful standards. In addition, without an existing set of standards, it isn't possible to resolve any new problems that emerge. The framework also increases financial statement users' understanding of and confidence in financial reporting and makes it easier to compare different companies' financial statements.

Navy Petty Officer 3rd Class Channing Connelly, right, uses a laser-guided level to check for proper frame elevation as other Seabees adjust a frame board while working on a building foundation at a patrol base in Mahawil, Iraq, Feb.

Boundless Accounting. Introduction to Accounting. The Accounting Concept. Conceptual frameworks can apply to many disciplines, but when specific ally related to financial reporting, a conceptual framework can be seen as a statement of generally accepted accounting principles GAAP that form a frame of reference for the evaluation of existing practices and the development of new ones.

As the purpose of financial reporting is to provide useful information as a basis for economic decision making, a conceptual framework will form a theoretical basis for determining how transactions should be measured historical value or current value and reported — ie how they are presented or communicated to users.

Some accountants have questioned whether a conceptual framework is necessary in order to produce reliable financial statements. Past history of standard setting bodies throughout the world tells us it is. In the absence of a conceptual framework, accounting standards were often produced that had serious defects — that is:. Such a system is very prescriptive and inflexible, but has the attraction of financial statements being more comparable and consistent.

The main purpose of the Framework is to:. The content of the Framework can be summarised as follows:. The development of t he Framework over the years has led to the IASB producing a body of world-class standards that have the following advantages for those companies that adopt them:.

It is not the purpose of this article to go through the detailed content of the Framework; this is well documented in many text books. This is because an understanding and application of these topics will be tested in exam questions and it is on these aspects that candidates perform rather poorly. As previously mentioned, this topic is generally examined as Question 4 worth 15 marks. Typically, the question will identify two or three areas of the Framework and ask for a definition or explanation of them — for example, the definition of assets and liabilities, an explanation of accounting concepts such as substance over form or materiality, or qualitative characteristics such as relevance and reliability.

Here are a few examples of past questions. Five of these are:. Part a is not much more than expected knowledge from F3, however Part b progresses this knowledge. It requires the application of each of the concepts, not to just any situation, but specifically to inventory thus illustrating how a single transaction inventory in this case can be subject to many different accounting concepts.