CHAPTER 2 CONCEPTUAL FRAMEWORK Objective To provide financial information that is useful to capital providers SFAC 8 Qualitative Characteristics Recognition and Measurement Concepts Primary Relevance Predictive value Confirmatory value Materiality Elements Faithful Representation Completeness Neutrality Free from error Enhancing Comparability including consistency Verifiability Timeliness Understandability SFAC 8 Assumptions Economic entity Going concern Periodicity Monetary unit Assets Liabilities Equity Investments by owners Distributions to owners Revenues Expenses Gains Losses Comprehensive income SFAC 6 Financial Statements Constraint Cost effectiveness SFAC 8 SFAC 5 SFAC 7 Principles Revenue recognition Expense recognition Mixed attribute measurement Full disclosure Balance sheet Income statement Statement of cash flows Statement of shareholders equity Statement of Comprehensive Income Related disclosures RECOGNITION AND MEASUREMENT Historical Cost States that asset and liability measurements should be based on the amount given or received in the exchange transaction Historical cost measurement provides important cash flow information and is also highly verifiable Realization Principle Revenue should be recognized only after the earnings process is virtually complete and there is reasonable certainty of collecting the asset Revenue should be recognized in the period it is earned not necessarily in the period in which cash is received Matching Principle Expenses are recognized in the same period as the related revenues Full disclosure Principle FULL DISCLOSURE PRINCIPLE The full disclosure principle means that the financial reports should include any information that could affect the decisions made by external users subject to the cost effectiveness constraint Supplemental information is disclosed in a variety of ways including parenthetical or modifying comments placed on the face of the financial statements Disclosure notes conveying additional insights about company operations accounting principles contractual agreements and pending litigation Supplemental financial statements that report more detailed information than is shown in the primary financial statements FAIR VALUE HIERARCHY Level 1 Most Desirable 2 3 Least Desirable Inputs Example Quoted market prices in active markets for identical assets or liabilities In Chapter 12 you will learn that certain investments in marketable securities are reported at their fair values Fair value in this case would be measured using the quoted market price from the NYSE NASDAQ or other exchange on which the security is traded Inputs other than quoted prices that are observable for the asset or liability These inputs include quoted prices for similar assets or liabilities in active or inactive markets and inputs that are derived principally from or corroborated by observable related market data In Chapter 10 we discuss how companies sometimes acquire assets with consideration other than cash In any noncash transaction the controlling valuation principle is that each element of the transaction is recorded at its fair value If one of the assets in the exchange is a building for instance then quoted market prices for similar buildings recently sold could be used to value the building or if there were no similar buildings recently exchanged from which to obtain a comparable market price valuation could be based on the price per square foot derived from observable market data Unobservable inputs that reflect the entity s own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances Asset retirement obligations AROs discussed in Chapter 10 are measured at fair value Neither level 1 nor level 2 inputs would be possible in most ARO valuation situations Fair value would be estimated using level 3 inputs to include the expected cash flows estimated using the entity s own data if there is no information that indicates that market participants would use different assumptions This level 3 input would be used in a present value calculation together with other inputs such as the credit adjusted risk free interest rate