Case 2-1

1a.A conceptual framework is like a constitution. “Its objective is to provide a coherent system of interrelated objectives and fundamentals that can lead to consistent standards, and that prescribes nature, function, and limits of financial accounting and financial statements.”(

Schroeder, R., Clark, M., & Cathey, J. (2014))

A conceptual framework is necessary so that standard setting is useful, an example being the“standard setting should build on and relate to an established body of concepts and objectives.”(Schroeder, R., Clark, M., & Cathey, J. (2014)) A well done conceptual framework should allow the FASB to issue more useful and consistent standards in the future.

Specific benefits that may arise are:

  1. A coherent set of standards and rules should exist.
  2. New and emerging problems should be more quickly solvable by reference to an already existing framework.
  3. It should increase financial statement users’ understanding of and confidence in financial reporting.
  4. It should enhance comparability among companies’ financial statements.
  5. It should determine the bounds for judgment in preparing the financial statements.
  6. It should guide the group responsible for establishing accounting standards.

1b.Relevance is one of the two fundamental qualities that make accounting information useful for decision-making. To be relevant, accounting information must be capable of making a difference in a decision –It must have predictive value, confirmatory value, or both. Financial information has predictive value if it has value as an input to predictive processes used by investors to form their own expectations about the future (for example, the cash flow statement helps investors predict a company's ability to pay dividends and service debt, in the future). “Relevant information also helps users confirm or correct previous expectations; it has confirmatory value” (for example, annual financial statements confirm or change the past, or present, expectations based on previous evaluations – sometimes referred to as earnings estimates).(Schroeder, R., Clark, M., & Cathey, J. (2014))

Materiality is an aspect of relevance that is not for every company. Information is material if you omitit or you misstate it and could influence decisions that users make due to the reported financial information. Companies and their auditors adopt the rule that anything under 5% of net income is considered immaterial.

Faithful representation is the second fundamental quality that makes accounting information useful for decision-making. Faithful representation means that the numbers and descriptions match what existed or happened. To be a faithful representation, information must be complete, neutral, and free of material error.

Completeness

“Completeness means that all the information that is necessary for faithful representation is provided.”(Chandran, S. (n.d.))An omission is information that is false or misleading and is not helpful to the users of financial reports.

Neutrality

“Neutrality means that a company cannot select information to favor one set of interested parties over another.”(Chandran, S. (n.d.))Unbiased information must be the overriding consideration.

Free from Error

Free from error will be a more faithful representation of a financial item. Faithful representation does not mean total freedom from error because most financial reporting measures involve estimates of various types that incorporate management judgment (such as estimated bad debts).

Enhancing Qualities

Enhancing qualitative characteristics are complementary to the fundamental qualitative characteristics. The enhancing characteristics are comparability, verifiability, timeliness, and understandability.

Comparability (falls under Relevance)

“Information that is measured and reported in a similar manner for different companies is considered comparable. Comparability enables users to identify the real similarities and differences in economic events between companies.”(Chandran, S. (n.d.))Another type of comparability is consistency which is present when a company applies the same accounting treatment to similar events. Companies can switch accounting methods but first must demonstrate that the newly adopted method is preferable to the old. If it is approved than the company must then share the nature and effect of the accounting change and the justification for it within the financial statements for the period in which it made the change.

Verifiability (falls under Relevance)

Verifiability happens when independent measurers get similar results. Verifiability occurs in the following situations:Two independent auditors count a company’s inventory and arrive at the same physical quantity (direct verification). Two independent auditors compute inventory value at the end of the year using the FIFO method of inventory valuation (indirect verification).

Timeliness (falls under Faithful Representation)

“Timeliness means having information available to decision-makers before it loses its capacity to influence decisions.”(Chandran, S. (n.d.))Having relevant information available sooner can help its capacity to influence decisions, and a lack of timeliness can rob information of its usefulness.

Understandability (falls under Faithful Representation)

“Understandability is the quality of information that lets reasonably informed users see its significance.”(Chandran, S. (n.d.))Understandability is enhanced when information is classified, characterized, and presented clearly and concisely.

References:

Chandran, S. (n.d.). Accounting Standards Well Defined By FASB. Retrieved August 30, 2015, from PubArticles:

Schroeder, R., Clark, M., & Cathey, J. (2014).Financial accounting theory and analysis: Text and cases. (11th ed.). Hoboken: John Wiley & Sons, Inc.

Investopedia. (2012). Accounting principles. Retrieved from

Case 2-2

2ai. FASB and IASB are working together on a project to “rebuild the foundations of financial reporting by revising the Conceptual Framework.” This project will be completed in phases and will provide a foundation for standards, somewhat like a constitution. This Conceptual Framework should provide a structure or a standard process for financial reporting standards that will be based on the primary principles, not as a solution to a particular issue.

2aii. The EITF identifies potential accounting problems as they occur and makes a determination as to whether they can be resolved quickly or if they should be turned over to FASB to solve. The EITF also issues statements that provide guidance on accounting for any new or unusual financial transactions that could create diversity in financial reporting.

2b. Since 1980, FASB and the AICPA have both investigated the need for small businesses to follow generally accepted accounting standards and have determined that small enterprises do not need to account for as many items as larger businesses or corporations, therefore, adherence to such standards are not cost effective or justifiable. These aspects of the standards overload problem pertaining to managerial accountants in all industries and the accounting industry as a whole are being discussed to determine methods to reduce the standards by identifying and matching them with the appropriate type and size of a business.

References:

Investopedia. (2012). Accounting principles. Retrieved from

Chandran, S. (n.d.). Accounting Standards Well Defined By FASB. Retrieved August 30, 2015, from PubArticles:

Schroeder, R., Clark, M., & Cathey, J. (2014).Financial accounting theory and analysis: Text and cases. (11th ed.). Hoboken: John Wiley & Sons, Inc.