The Pursuit of The Conceptual Framework: 1. Paton William

ACCT THEORY ACCT3040
MY NOTES
CHAPTER 2
The pursuit of the conceptual framework
The Conceptual Framework Project (CFP) developed to guide standards and resolve
accounting issues.
The Early Theorists
First attempt to develop accounting theory began with:
1. Paton William
Change in assets and liabilities should be reflected in the Financial
Statements on a current value basis.
Returns to investors (dividends and income) were distributions of income.
2. Canning John
Asset valuations and measurement were based on future expectations.
Match revenues and expenses were based on future expectations.
Scott and Veblen viewed the industrial revolution as changing fundamental that
caused managers to look for new methods of maintaining organizational control.
Scott framework includes hierachry of postulates and principles used in the
development of accounting rules and techniques are:
Orientation Postulate
Consideration of current, social, political and economic environment.
Level 1
Pervasive principle of Justice
Developing accounting rules that offer equitable treatment to all users of
financial statements.
Principles of Truth and Fairness
Presenting accurate information and attributes of objectivity, freedom from
bias and impartiality.
Principles of adaptability and consistency
Being able to change accounting in reference to economic conditions and
maintaining consistency in accounting rules.
Level 4
The Accounting Research Study published a hierarchy of postulates entitled, The

basic Postulates of Accounting, as follows:
GROUP AThis focuses on economic and political environment.
This includes: Quantification (quantitative data)
Exchange of good and services
Entities
Time Period
Unit of Measure

MY NOTES
CHAPTER 2
GROUP B- Accounting Postulates
This focuses on the field of accounting. It includes:
Financial Statement
Market Prices
Entities (accounting process expressed in terms of units or entities)
Tentativeness (Operations for short periods)
GROUP C-Imperative Postulates
This represents what statement should be than what it is. It includes:
Continuity (operation is indefinitely)
Objectivity
Consistency
Stable Unit
Disclosure
Accounting Research Study ARS 3
States the used of current values in accounting measurements.
The used of discounted present values for accounting measurements is
widely accepted but was in conflict with SECs long-term advocacy.
Accounting Principles Board- APB 4
Users of financial statements should be knowledgeable and understand the
characteristics and limitations of financial statements.
A Statement of Basic Accounting Theory ASOBAT
The TrueBlood Committee
Stated that an entity rely on financial statements for decision making, effectively
directing and controlling the organization, maintaining and reporting and facilitating
social functions and controls.
Statement on Accounting Theory and Theory Acceptance
Review of the status of accounting theory and its acceptance.
NOTE:
The committee conclusion was that a single universally accepted basic accounting
theory did not exist.
Three approaches are:
1. The Classical Approach
Ignored historical cost and generally advocates the use of current values.
Deductive school- income measure a single valuation base to meet the needs of
all users.
Inductive school- rationalize or justify existing accounting practise.
2. Decision- Usefulness Approach
The use of decision making models

MY NOTES
CHAPTER 2
3. Information Economics
Information treated as a community that has cost and prices and examine
whether regulation of external financial reporting is desirable.
Criticism of the approaches to theory
The real world is much more complex than specified in accounting

theory.
Allocation is an arbitrary process.
Different users have different desired. No set of standard can satisfy
all users.
Most existing theories do not indicate how to measure benefits and
costs
Users have limited ability to process accounting
information.
FASBs Conceptual Framework Project

Common basis for identifying and discussing issues, asking relevant
questions and suggesting avenues for research. CFP issued Statement of Financial
Accounting Concepts (SFAC) are as follows:
SFAC NO 1: Objectives of Financial Reporting by Business Enterprise.
Indicates the objectives of financial statements and the usefulness of
information by management to users who can obtain information in no other
way.
The objectives are to be used as guidelines for making investment and credit
decision.
Objectives: Assess cash-flow prospects, report enterprise resources, report
enterprise performance, evaluate liquidity, solvency and management
stewardship.
SFAC NO 2: Qualitative Characteristics of Accounting Information
This addresses, what characteristics of accounting information make it
useful?
SFAC NO 2 notes that accounting choices are based on:
* First, FASB or agencies power to require business to report in a particular
way
* Second, Choices between acceptable alternatives

MY NOTES
CHAPTER 2
The qualities that distinguish between the usefulness of information are:
IMP

MY NOTES
CHAPTER 2
SFAC NO 5: Recognition and Measurement in Financial Statements of

Business Enterprises
SFAC NO 5 set forth recognition criteria and guidance on what information
should be incorporated into financial statements and when should this
information be reported.
Comprehensive income is the change in equity of an entity during a period of
transactions and events.
Earnings are a measure of an entity performance during a period.
Relationship between comprehensive income and earnings:
Revenues
Less: Expense
Plus: Gains
Less: Losses
= Earnings/Comprehensive Income
SFAC NO 5 also addresses the recognition criteria for measurements as
follows:
* Definitions- item meets the definition of an element
* Measurability Relevant attribute with sufficient reliability
* Relevance- Capable of making a difference in user decisions
* Reliability- Information is representationally faithful, verifiable and neutral
NOTE: Recognition of revenues and gains is based on: 1) being realized or
realizable 2) being earned before recognized as income.
FAILURE OF SFAC NO 5:
~ Doesnt define earnings
~ Doesnt resolve current value vs historical cost
SFAC NO 6: Elements of Financial Statements of Business Enterprise
Elements used to measure performance and financial positions of economic
entities are:
* Assets
* Liabilities
* Equity
*Losses
* Investments by owners
* Distributions to owners
* Comprehensive Income
*Revenues
* Expense
* Gains
SFAC NO 7: Using Cash Flow Information and Present Value in Accounting

Measurements
Used for the time of initial recognition of assets.
NOTE:
Assets are distinguished from one another by the timing and uncertainty of
their future cash flows.
Economic differences between five assets includes the following elements:
a. An estimate of future cash flows.
b. Expectations about variations in the timing of cash flows.

MY NOTES
CHAPTER 2
c. Time value of money represented by risk-free rate of interest.
d. Price for bearing uncertainty
e. Unidentifiable factors (illiquidity and market imperfections)
Approaches to present value:
Traditional single cash flow and a single interest rate
Expected cash flow range of possible cash flows with a range of likelihood
Principles- Based vs Rules- Based
NOTE:
Unethical accounting practices enabled companies like Enron and WorldCom to bilk
investors out of huge sums of money.
In response, Congress passed the Sarbanes-Oxley Act of 2002 to authorize the
Securities and Exchange Commission to explore reforms to rules-based accounting
systems.
PRINCIPLES- BASED
Present enforcement difficulties
Little guidance or structure
Better able to cope with speed of
RULES- BASED
Provide a vehicle for
circumventing the intention of
change business enviro

Less voluminous
Encourages professional
the standard
More workable in large, complex
judgement
economies and countries

Less room for interpretation
Provides guidance for practical
NOTE:
implementation
Avoid rules in favour of guidelines

NOTE:
Set Standards in the form of detailed
rules.
International Convergence
Norwalk Agreement developed high quality and compatible standards used for
financial reporting.
As part of the Norwalk agreement, FASB & IASB agreed to:
- Remove a variety of individual differences between US GAAP and IFRS
- Encourage respective interpretative bodies to coordinate their activities.

MY NOTES
CHAPTER 2
In 2006 a Memorandum of Understanding (MOU) was signed in the process of
convergence. It outlined the road map for elimination of the reconciliation
requirement for non US companies.

The Pursuit of The Conceptual Framework: 1. Paton William

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ACCT THEORY ACCT3040

The Accounting Research Study published a hierarchy of postulates entitled, The

ACCT THEORY ACCT3040

ACCT THEORY ACCT3040

Criticism of the approaches to theory

The real world is much more complex than specified in accounting

FASBs Conceptual Framework Project

ACCT THEORY ACCT3040

ACCT THEORY ACCT3040

SFAC NO 5: Recognition and Measurement in Financial Statements of

SFAC NO 7: Using Cash Flow Information and Present Value in Accounting

ACCT THEORY ACCT3040

change business enviro

economies and countries

Avoid rules in favour of guidelines

ACCT THEORY ACCT3040

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