Why we need Conceptual Framework

A conceptual framework is like a set of rules or principles that help make financial reporting more
consistent and reliable. Here's why it's important:

1) Consistency and Clarity: Imagine if everyone had their own way of deciding how to report financial
information. It would be chaotic! A conceptual framework provides a common set of rules that
everyone can follow, so financial reports are more consistent and easier to understand. After a fixed
period, a rough draft is pronounced which creates a standard for financial reporting for all the
organization.
2) Problem-Solving: Sometimes, new situations arise in the business world, like issuing bonds with
different payment options. Without a framework to guide them, accountants might struggle to
figure out how to record these transactions correctly. But with a conceptual framework, they have a
set of principles to refer to, making it easier to solve tricky problems like these.

So, basically, a conceptual framework helps make financial reporting more consistent, clear, and
adaptable to new situations, which is crucial for businesses and investors to understand and trust
financial information.

Levels of Conceptual Framework

Basic Objective

Simply put, the objective of financial reporting is to provide useful information to investors, lenders, and
other creditors so they can make informed decisions about whether to invest in or lend money to a
company. This information helps them understand the company's financial health, profitability, and
ability to generate future cash flows.

Financial reporting also helps evaluate how well management is using the company's resources to create
value, known as stewardship. It shows how efficiently and effectively management and the board of
directors are managing the company's finances.

General-purpose financial reporting provides information that users, like investors and creditors, need
to make decisions about providing resources to a company. It assumes that users have some knowledge
of business and financial accounting to understand the information in financial statements.

In summary, financial reporting aims to give users the information they need to make decisions about
investing or lending to a company and assess how well management is managing the company's
resources.

Economic Entity Assumption

This assumption is important because it allows users of financial statements to understand the
performance of each company individually. For instance, investors can compare companies like Volvo,
Ford, and Volkswagen to see which one is doing better financially.

The entity concept doesn't just apply to separate companies like Toyota and Hyundai. It can also apply
to individual departments, divisions, or even entire industries. So, even though a parent company and its
subsidiaries are legally separate, they can still be treated as one entity for accounting and reporting
purposes without violating the economic entity assumption.

Going Concern Assumption

The going concern assumption is the idea that a company will continue to operate for the foreseeable
future. Despite some businesses failing, most companies are expected to continue operating long
enough to meet their goals and obligations.

This assumption affects how we value assets and liabilities. For example, if we thought a company would
soon liquidate, we might value its assets differently—perhaps at their current market value rather than
what the company paid for them. Similarly, we might not use depreciation or amortization methods if
we thought the company wouldn't last long enough to benefit from them.

The going concern assumption also affects how we classify assets and liabilities. If a company is expected
to continue operating, we can confidently label some assets as long-term or non-current. But if a
company might liquidate soon, this classification becomes less meaningful.

Overall, the going concern assumption applies in most situations, except when a company is on the brink
of liquidation. In those cases, we might need to reassess how we value and classify its assets and
liabilities.

Monetary Unit Assumption

The monetary unit assumption says that money is the basis for measuring and analyzing economic
activity in accounting. In other words, we use money as the common language to express changes in
capital and transactions involving goods and services. This assumption relies on the idea that using
numbers is helpful for understanding economic information and making smart decisions.

Additionally, accounting usually doesn't adjust for changes in prices (like inflation or deflation). It
assumes that the value of the currency remains relatively stable over time. So, we might add up
amounts in pounds from different years without adjusting for inflation. However, if there were extreme
changes in prices (like really high inflation), we might need to consider using "inflation accounting" to
adjust for those changes. But typically, we stick to using the monetary unit assumption for simplicity and
practicality.
Periodicity Assumption

The periodicity assumption says that companies need to report their financial information regularly,
even though they can't wait until they're completely done with their business activities. This is because
users of financial information, like investors and creditors, need to know how a company is doing on a
timely basis to make decisions.

Companies divide their financial activities into artificial time periods, like months, quarters, or years. The
shorter the time period, the harder it is to accurately measure a company's performance for that period.
For example, monthly results might be less reliable than quarterly results, and quarterly results might be
less reliable than yearly results.

Investors want companies to release financial information quickly, but doing so increases the risk of
errors. This shows a trade-off between providing information quickly (relevance) and making sure it's
accurate (faithful representation).

As products become outdated more quickly due to technological advances, the challenge of defining the
right time period for reporting financial information becomes even more important. Many people think
that companies should provide more real-time financial information online to keep up with these
changes and make sure relevant information is available when needed.

# Basic of Accounting

1) Historical Cost Principle:

This principle states that assets should be recorded on the balance sheet at their original purchase price
or acquisition cost.

Example: A company purchases a piece of machinery for $10,000. According to the historical cost
principle, the machinery would be recorded on the balance sheet at its purchase price of $10,000.

2) Current Value:

Current value refers to the present worth of an asset or liability, taking into account factors such as
market conditions, supply and demand, and inflation.

Example: A company's inventory of goods may have a current value higher or lower than its historical
cost, depending on changes in market prices or demand. If the market price of the inventory has
increased since purchase, its current value would be higher than its historical cost.

3) Fair Value:

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date.
Example: If a company owns shares of stock, the fair value of those shares would be the current market
price of the stock. If the market price is $50 per share, then the fair value of each share owned by the
company would be $50.

( Fair value refers to the price that would be received to sell an asset or paid to transfer a liability in an
orderly transaction between market participants at the measurement date.

It takes into account market conditions, supply and demand, and other relevant factors at the specific
measurement date.

Fair value often represents the most accurate and up-to-date valuation of an asset or liability.

Example: The fair value of a company's investment in a publicly traded stock would be the current
market price of the stock.

Current Value:

Current value, on the other hand, refers to the present worth of an asset or liability, taking into account
factors such as market conditions, supply and demand, and inflation.

It may not necessarily reflect the price that would be received in an immediate sale or transfer of the
asset or liability.

Current value may consider broader economic conditions and the timing of potential transactions.

Example: The current value of a company's inventory may be higher or lower than its historical cost,
depending on changes in market prices or demand, but it may not represent the precise market price at
the specific measurement date. )

Revenue Recognition:

Revenue recognition is the accounting principle that determines when and how to recognize revenue in
the financial statements.

Revenue is typically recognized when it is earned and realized or realizable, meaning when goods are
delivered or services are rendered, and payment is reasonably assured.

Example: A software company sells a one-year subscription to its software for $1,200. The company
recognizes revenue evenly over the subscription period, recognizing $100 of revenue each month as the
service is provided to the customer.

Expense Recognition:

Expense recognition, also known as the matching principle, is the accounting principle that determines
when to recognize expenses in the financial statements.

Expenses are typically recognized in the period in which they are incurred to generate revenue, rather
than when the cash is paid.
Example: A manufacturing company purchases raw materials for $5,000 in January but uses these
materials to produce finished goods in February. The company recognizes the $5,000 as an expense in
February when the goods are produced and revenue is earned, rather than when the materials were
initially purchased.