Conceptual framework- definition:
Conceptual framework is a basic structure with a view to providing information to the users.
Conceptual framework consists of two terms: Conceptual & framework. Conceptual means "idea or plan. On the other hand, "framework" means essential supporting structure or basic structure". So Conceptual framework for accounting information stands for the plan or ideas pf basic structure of generating and presenting accounting information to a diversified group of users for decision making.
Need for conceptual framework:
Generally speaking, the rationale behind developing a conceptual framework is to, widen the acceptability to users, to increase users' understandability and to provide, proper accounting treatment.
Two needs of developing such framework are as follows:
1. To ensure worldwide acceptability of accounting and to enhance the users,
Understanding of and confidence in financial reporting and
2. New and practical problems relating to accounting in the complex business field can be solved with the help of such framework.
Levels in Conceptual Framework:
1. First level: object of financial reporting.
2. Second level-. Qualitative characteristics + Elements of financial statements
3. Third level: Recognition & measurement of concepts.
Explain the framework:
1. The first level explains the’ why'- goals and purpose of accounting.
2. The second level links up the first level with the third level and
3. The third level describes the' how'- implementation of accounting rationally.
First level-objective of financial reporting:
Objective
Users
Decision
1st
Investor & creditor
For the investment and credit decision these users must have a reasonable understanding of business and economic activities
2nd
Users specially present and potential investor and creditor
For cash flow project
3rd
To a diversified group of a user
About economics resource, the claims on these resources and change on them
2nd Level: (Qualitative characteristics of accounting. Information)
A) Primary Qualities:
1. Relevance:
Relevance makes the accounting information more useful for decision making.
Accounting information is relevant to the extent that it is useful and meaningful to the user who use-it. This can affect users' decision. In- other words, another decision can be made if relevant information is not available.
To be relevant, accounting information must be capable of making a difference in a decision.
To be relevant, information needs the following criteria:
> Feedback value
> Predictive value &
> Timeliness
Feedback value:
Help users confirm or correct prior expectation .it tells about the performance of the business entity over a certain period of time.
Predictive value:
Helps users predict about the future condition of the business entity. It helps users to plan for future.
Timeliness:
Helps users to make the right decision. To be relevant, information must be presented on a timely basis.
2. Reliability:
Reliability refers as the dependability of the users on information
Reliability is another significant primary quality to make information meaningful.
Accounting information is reliable to the extent that users can depend upon the information in a decision. To be reliable, information need to fulfill the following criteria:
? Verifiability
? Neutrality &
? Accuracy (Representational faithfulness)
Verifiability:
Accounting information must be credible and unjustifiable by independent parties using the same methods of measuring it.
Neutrality:
Information cannot be selected to favor one set of interested parties usually management) over another. It must fair and factual, not biased.
Accuracy:
Information must represent what it is meant to represent. It should convey business activities as faithfully as possible without influencing anyone in a specific direction. It should be free from at least any intentional error.
Example:
The balance sheet should represent the assets, liabilities and owner's equity of a business enterprise over a certain period of time as faithfully as possible (Accuracy) without any bias (neutrality) which can be verifiable by an auditor (Verifiability).
B) Secondary qualities:
Comparability and consistency are two important secondary qualities. Information about an enterprise is more useful if it can be compared with similar information about another enterprise (Comparability) and with similar information about the enterprise over time.
Comparability:
Information that has -been measured and reported in a similar manner for different enterprises is considered comparable. The users compare between similar information of different enterprises and have practical ideas about the similarities and the differences of information. This will lead the users to make the right decision. But the users must keep in mind that comparison between enterprises becomes appropriate when the nature of the business entity is of the same nature.
Example:
Dutch-Bangla bank gave bonus ten times in the year 2003 whereas the IFIC bank gave bonus four times in the same year. This information can be compared in a meaningful way.
Consistency:
When an entity applies the same accounting treatment to similar events, from period to period, the entity is considered to be consistent in the use of accounting standards. This does not mean that companies cannot switch from one method of accounting to another. But the nature and effect of the accounting change; as well as the justification for it, must be disclosed in the financial statements for the period in which the change is made. Consistent use of accounting measures and procedures is important in achieving comparability.
Example:
In a business enterprise, the accountant changes its depreciation -policy (from straight-line to declining balance method) for its fixed assets as per the instruction of the management. Management provides a note to the financial statements explaining that the new method is more justifiable than the old method of depreciation because the use of fixed assets is usually higher in the earlier years of their expected life.
2'd Level: (Elements of financial statements):
Basic Elements:
A) Asset b) Liability c) Owner's equity
Other Elements:
A) Investment by owners b) Distributions to owners c) Revenues d) Expenses e) Gains f) Losses g) Comprehensive income
3rd Level: Recognition & measurement of concepts:
Generally Accepted Accounting Principles (GAAP):
Every business entity prepares its financial statements and reports in-'accordance with certain universally accepted accounting principles and concepts. These accounting Principles and concepts provide the preparers and providers of financial statements with a
Set of guidelines, standards and boundaries. They commonly known as General
Accepted Accounting Principles (GAAP). They also aid in global harmonization and Consistency in accounting practice all over the world. GAAP is of great essence to the found understanding of financial accounting basics.
The third level of the conceptual framework i.e. the recognition and measurement concepts comprises of the underlying concepts of GAAP.
A) Basic Assumption:
A-1: Economic entity /Business entity assumption:
Economic entity assumption means that the entity of the business is separate from the Entity of the owner and also from other business u its (if any) of the same owner. In other Words, it means that economic activity can be identified with a particular unit of Accountability. Simply speaking, Separate of books should be maintained for a Business as a separate economic entity. Sole proprietor, firm or company is the example of entity. Show the limits as to what info m-a-h-o-n-should be included in the financial Statements of a given entity. For reports and decisions to be effective, businesses must follow this assumption. So business entity assumption reflects two things:
A) A business is accounted for separately from its owner or owners.
B) We account for each business separately that is controlled the same owner
Example:
A) Any sum withdraw by t e owner or personal expenses of the owner met by the entity
Is recorded as drawings because the entity's account is separate from the account of the Owner according to the entity concept.
B) Mr. X has two business entities: a petrol pump and a fast food shop. The first, one makes a profit of tk. 20,000 and the later makes a loss, of tk. 14000. Both should be shown in the accounting records separately.
A-2: Going concern assumption:
It is also known as the continuing-concern' assumption. In general, accounting believes that the business entity is a going concern meaning that the &is entity will continue to operate for an indefinite period of time, at least long enough to carry out its existing plans and contracts. Simply to say, it has a long life, it is not expected to be liquidated. The going concern is not applicable in case of liquidation only. In contrast, a project has expected life, no, the business.
Starting point
End time
Project
Known
Known
Business
Known
Unknown
In absence of this assumption, plant assets should be stated at their liquidation value (selling price less cost of sale), not at -cost price. In that case, depreciation and amortization of these assets is not needed. Again, classified balance sheet and classified income statement preparation becomes difficult (As current and long-term classification of assets and liabilities is not material).
Example:
Issues of share, charging depreciation etc. Reflect--this’ assumption
A-3: Monetary unit assumption:
Monetary assumption means that business transactions events or accounting information is measured in term of money. It provides an appropriate basis for accounting treatment and analysis. If accounting transactions are measured in different units, the entity cannot display its financial position and operating result. In this regard, accounting generally assumes stable monetary unit meaning the value of money (tk.) In terms of its ability to purchase certain goods or services is constant over time. It ignores inflation (price change) in accounting records. Under this concept, we assume that the changing prices have no impact on financial figures that are already recorded.
In absence of this assumption, accounting cannot campmate information to the users effectively. Again, user cannot compare the operating 'results of an entity with that of another entity and make decisions effectively.
Example:
A), the efficient 6ecutive of a business entity switched to another business. We have substantial, loss. But can not be terms of money. So it is not recoded in the accounting books.
B) A business owns tk. 30,000 of cash, 6,000 tons of raw materials and 5 trucks. These amounts cannot be added together to produce a meaningful total of what the Business owns. As different units of measure are there.
A-4: Accounting period assumption:
Accounting Period means the presentation of information for a, specified period.
Accounting measures activities for a specified interval of time, called the accounting period. The time periods vary entity to entity and in accordance to the need of the management. It may be monthly, quarterly, biannually or annually. But one year is the usual accounting period for the purpose of reporting to outside.
Luca Pacioli, the first anther of an accounting text, wrote in 1494:
"Books should be closed each year, especially in a partnership, because frequent -accounting makes for long friendship."
Most corporate, bylaws require an, annual report to the shareholders and income tax reporting is also on an annual basic.
Financial or fiscal year
1st July -30th June
Calendar year
1st January -31st December
Bangla year
14th April-13th April
Examples:
1. Most companies publish annual report so, that the readers of the report can assess the overall performance of the business meaningfully. If it is published haphazardly ', i.e. Without maintaining any accounting period, the information cannot be properly assessed ,compared or even understood by the user.
2. Accrued salary of a. Financial year is added with the salary of that financial year though this may be received next fanatical year, for the’ same purpose, any prepaid expense or income deducted in the income statements.
B) Principles:
B-1.Historical cost principal:
Cost is the amount given UP to purchase an asset or service. Accepted accounting practice requires that assets and liabilities should be recorded and reported on the basis of acquision / cost price. Because for a variety- of -reasons, the real worth -of an asset or liability may change with the passage of time. Other valuation very likely market value is not considered. Cost principle has an added advantage over other valuation.
Cost I is both reliable and relevant. Cost is reliable because it is factual and verifiable. Cost is relevant because it represents the price paid. It is also objective than measurable. For example, reporting purchases of asset or services at cost is more objective than reporting a manager's estimate’, of their value.
Market value or other valuati6n is an estimate and not reliable. Moreover,' value is also subject to change i.e. It is not stable.
Historical cost principle severely criticized over the world. Two most common criticisms are discussed below:
A) Do not reflect price level change
B) Do not provide for increased cost of replacement
Example:
If a business entity purchases an asset costing tk. 50,000. Currently it is selling in the market for tk. 60,000. While recording the value of asset in the book, accountants will record tk. 50,000 (cost price of asset).
Notes payable issued by a company for services taken at price is recorded in the accounting records.
B-2: Revenue recognition principle:
Revenues are inflows of assets resulting from providing a product or service to a customer. The revenue recognition principle is also called the realization principle. Recognition of revenue is the act of recording revenue in the accounting records and reporting it in the income statement. Revenue is generally recognized when
l Earned and
l Either realized or realizable
In the first, case, Revenue is considered as earned when the entity has done the exchange of goods or services, to its--customers i.e. When services are, rendered or -the seller transfer ownership of goods sold to the customer. Amount that is realized realizable is not revenue until it is earned. Mainly, revenue should be recognized at the time of sale of goods or rendering of services.
In the second case, revenues are realized when goods, services or assets are exchanged for cash. Revenues are realizable when goods, services or assets are exchanged for cash or other assets to be realized at any future date.
Example:
1. When cash is realized:
A customer buys a compact disk, form a shop of Eastern Plaza for tk. 50 cash; the shop realizes tk. 50 as revenue.
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