Financial Accounting Standards Board _FASB_ - WLU by pptfiles

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									CONCEPTUAL FRAMEWORK &
   STANDARD SETTING
       GROUP B
                       AGENDA

•   FASB’s Conceptual Framework
•   Successes of the Framework
•   Failures of the Framework
•   Relevance vs. Reliability
•   Tradeoff with Examples
FINANCIAL ACCOUNTING STANDARDS BOA
             (FASB)
• Not-for-profit organization created in 1973
• Primary purpose is to act in the public’s interest by
  setting generally accepted accounting principles in the
  U.S.
• Designated by the Securities and Exchange Commission
  (SEC) to set standards for U.S. public companies




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  FASB       of the CF     the CF       Reliability    Examples
            CONCEPTUAL FRAMEWORK

• Developed by FASB to provide the accounting profession
  a generally accepted framework
• Wanted financial reporting to provide useful information
  to decision makers
• Sets the objectives, qualitative characteristics and other
  concepts that help guide the profession in choosing
  which economic events should be recognized and
  measured for financial reporting and how they are
  presented (3 levels)

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            CONCEPTUAL FRAMEWORK

• These 3 levels are outlined in statements of financial
  accounting concepts (SFACs)
• A basis on which standards are set and allows the board
  to develop more useful and consistent standards over
  time which allow for more reliable and relevant
  reporting




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               CICA SECTION 1000

• Outlines the financial statement concepts that are used
  in the generally accepted accounting principles
• Section 1100 establishes the actual accounting principles




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             SUCCESSES OF THE FRAMEWORK

1. Guidance for Standard Setting
   § Provides users with guidance in standards setting &
     applying concepts that can be measured by their
     ability to achieve the goals of the accounting function
2. Economies of FASB’s time
   § Many accounting cases have common points with
     other accounting issues, thus the conceptual
     framework provides an effective solution to a variety
     of issues

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             SUCCESSES OF THE FRAMEWORK

3. Broad, perspective concepts
   § Concepts contained in the framework should be
     fundamental, in order to allow other concepts to flow
     from them
4. Apolitical Standards
   § The framework should result in standards that have
       not been developed as a result of political pressure
       on the FASB


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            SUCCESSES OF THE FRAMEWORK

5. Avoids inconsistencies between standards
   § The framework provides an opportunity to reconcile
     concepts based on accounting principles to ensure
     consistent application


 Ø Statements of Financial Accounting Concept
   Ø 7 SFAC’s comprising the conceptual framework
   Ø Justification of standard setting (SFAS) by the FASB

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              OPPOSING OPINIONS

ØPractitioners from small and mid-size firms disagrees
 that a conceptual framework would add any value to the
 existing problems
ØHickok argues accountants merely report events of the
 past, it is not up to them to be forward thinking
ØOut of the 63 statements and 44 interpretations issued
 by the FASB between 1979 and 1985, only 28 references
 to the conceptual framework was made


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                        SFAC 5

ØRevenue recognition and measurement
 § Repeats what has been said in existing standards
 § Does not set insight on how to solve complex
   accounting issues and what methods are preferable
 § Example: Accounting for income taxes (SFAS 96)-
   measurement and recognition of deferred taxes




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                          SFAC 2

ØQualitative Characteristics of Accounting Information
  ØSFAC 2 mainly introduces the importance of reliability and
   relevancy of accounting information to decision makers
  ØSFAC 2 was bent and twisted to fit the use of FASB on foreign
   exchange issues (SFAS 52)
  ØExplains how the conceptual framework is not useful to making
   consistent decisions




 Intro to     Successes     Failures of   Relevance v.   Tradeoffs &
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                        TO ILLUSTRATE…

ØCompany A is a Canadian company that has a subsidiary in Australia
 called Company B. Company has inventory recorded at historical
 cost of $100 and the market value of the inventory today is $105.
 The historical exchange rate at the date the inventory was acquired
 is 1.5 and the exchange rate today is 1.
Ø Company A will need to write down inventory where Company B
 uses historical cost. This presents inconsistency in information.

                             Historical Cost   Market Value
            Company A        $100 x 1.5 = $150 $105 x 1 = $105
            Company B        $100              $105


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OBJECTIVES OF FINANCIAL REPORTING: SFAC
                1978
• Objective: to provide useful information in order for
  financial statement users to make decisions
• Stem from the primary needs of financial statement users,
  to provide relevant information for decision making
• Users are assumed to have a reasonable understanding
  of business and economic activities
• Intended for a broad use, general purpose in nature



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 PRIMARY QUALITIES OF USEFUL INFORMATI
           SFAC 2, 1980
• Relevance and reliability are the 2 primary qualities
  • Verifiability and Representational Faithfulness
  • Neutrality
  • Comparability and Consistency
• Constrained by:
  • Materiality
  • Cost and Benefits


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      WHAT CONSTITUTES AS RESOURCES TO AN
         ENTERPRISE? SFAC 6, 1985
ØBasic elements of financial statements include the
 following:
  § Assets
  § Liabilities
  § Equity
  § Revenues
  § Expenses
  § Gains
  § Losses

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  WHEN SHOULD RESOURCES BE RECOGNI
          SFAC 5, 1984
ØMust meet 4 fundamental recognition criteria for a
 resource to be recognized:
  1. Definitions
  2. Measurability
  3. Relevance
  4. Reliability
  § Subject to Cost-benefits and materiality


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            RELEVANCE VS. RELIABILITY

ØRelevance: information is timely and reflects the
 company’s current financial position
ØReliability: information can be objectively verified by an
 outside third-party source
ØFASB’s Concept Statement states both are equally
 important




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            ACCOUNTING LOSES FOCUS ON REALITY

ØAccounting has lost its relevance because it fails to
 recognize some intangibles
  § Brand: Coke and Nike
  § R&D: Microsoft
  § Human Capital: McDonald’s
ØAccounting practices have neglected the “future
 economic benefit” of intangibles and focus too much on
 expenses

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            ACCOUNTING REMAINS PATIENT

ØAs pointed out in the conceptual framework “Financial
 accounting is not designed to measure directly the value
 of a business enterprise”
ØTo base usefulness on the stock market valuation would
 be irrational as it would be based on a people’s non-
 sensical emotions




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            ACCOUNTING REMAINS PATIENT

ØIntangibles should be classified on the financial
 statements when they can reliably measured –
 “reasonably free from error”
ØOther characteristics not solely “future economic
 benefit” are included when categorizing an element as
 an asset
  § Coke
  § Microsoft
  § McDonald’s
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       TRADE-OFFS BETWEEN RELEVANCE AND
                RELIABILITY
ØDefinition: The exchange of one thing for another of
 more or less equal value, especially to affect a
 compromise.
ØReliability dominates relevance
 § Timeliness
ØRelevance dominates reliability
 § Errors



 Intro to    Successes   Failures of   Relevance v.   Tradeoffs &
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              EXAMPLES OF TRADE-OFFS

ØAfter the balance sheet date but before the date of issue a
 company wants to dispose of one of its subsidiaries and is in final
 stages of reaching a deal but the outcome is still uncertain. If the
 company waits they are expected to find more reliable information
 but that would cost them relevance. The information would be
 outdated and no longer very relevant.
ØAfter the balance sheet date during the time when audit is carried
 out, it becomes clear which debts were realized and where were
 not hence it improves the reliability of allowance for bad debts
 estimate but the information loses its relevance due to too much
 time being taken. Timeliness is key to relevance.

 Intro to      Successes      Failures of   Relevance v.    Tradeoffs &
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            DIFFERENT GROUP PERCEPTIONS

ØPreparers of financial statements put greater emphasis
 on reliability measures to pass audit scrutiny
ØAuditors of financial statements put greater emphasis on
 reliability measures due to their legal exposure
ØInvestors put greater emphasis on relevance on
 forecasting the company’s future earnings and financial
 position



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                  FASB’S CONCEPT 2

Ø“Concepts Statement 2 states: The qualities that
 distinguish “better” (more useful) information from
 “inferior” (less useful) information are primarily the
 qualities of relevance and reliability. . . . The objective of
 accounting policy decisions is to produce accounting
 information that is relevant to the purposes to be served
 and is reliable.” [Paragraph 15]
ØTo be useful Concept 2 under FASB states that financial
 information must be both relevant and reliable

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                 EARNINGS QUALITY

ØWhether a firm’s financial statements truly reflect its
 financial position
ØThe economic value of transactions can be interpreted
 differently; the most “correct” way has the highest level
 of earnings quality
ØAssociated with conservative accounting policies
ØRelated to accounting ethics



 Intro to    Successes    Failures of   Relevance v.   Tradeoffs &
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