Reading: Lesson 6 - The financial accounting standards board's conceptual framework project

Experts have debated the exact nature of the basic concepts and related principles composing accounting theory for years. The debate continues today despite numerous references to generally accepted accounting principles (GAAP). To date, all attempts to present a concise statement of GAAP have received only limited acceptance. Due to this limited success, many accountants suggest that the starting point in reaching a concise statement of GAAP is to seek agreement on the objectives of financial accounting and reporting. The belief is that if a person (1) carefully studies the environment, (2) knows what objectives are sought, (3) can identify certain qualitative traits of accounting information, and (4) can define the basic elements of financial statements, that person can discover the principles and standards leading to the stated objectives. The FASB completed the first three goals by publishing "Objectives of Financial Reporting by Business Enterprises" and "Qualitative Characteristics of Accounting Information".4 Addressing the fourth goal are concepts statements entitled "Elements of Financial Statements of Business Enterprises" and "Elements of Financial Statements".

Objectives of financial reporting

Financial reporting objectives are the broad overriding goals sought by accountants engaging in financial reporting. According to the FASB, the first objective of financial reporting is to: provide information that is useful to present and potential investors and creditors and other users in making rational investment, credit, and similar decisions. The information should be comprehensible to those who have a reasonable understanding of business and economic activities and are willing to study the information with reasonable diligence.

Interpreted broadly, the term other users includes employees, security analysts, brokers, and lawyers. Financial reporting should provide information to all who are willing to learn to use it properly.

The second objective of financial reporting is to: provide information to help present and potential investors and creditors and other users in assessing the amounts, timing, and uncertainty of prospective cash receipts from dividends [owner withdrawals] or interest and the proceeds from the sale, redemption, or maturity of securities or loans. Since investors' and creditors' cash flows are related to enterprise cash flows, financial reporting should provide information to help investors, creditors, and others assess the amounts, timing, and uncertainty of prospective net cash inflows to the related enterprise.

This objective ties the cash flows of investors (owners) and creditors to the cash flows of the enterprise, a tie-in that appears entirely logical. Enterprise cash inflows are the source of cash for dividends, interest, and the redemption of maturing debt. Third, financial reporting should:

provide information about the economic resources of an enterprise, the claims to those resources (obligations of the enterprise to transfer resources to other entities and owners' equity), and the effects of transactions, events, and circumstances that change its resources and claims to those resources.

We can draw some conclusions from these three objectives and from a study of the environment in which financial reporting is carried out. For example, financial reporting should:

• Provide information about an enterprise's past performance because such information is a basis for predicting future enterprise performance.
  
• Focus on earnings and its components, despite the emphasis in the objectives on cash flows. (Earnings computed under the accrual basis generally provide a better indicator of ability to generate favorable cash flows than do statements prepared under the cash basis.)
  

On the other hand, financial reporting does not seek to:

• Measure the value of an enterprise but to provide information useful in determining its value.
  
• Evaluate management's performance, predict earnings, assess risk, or estimate earning power but to provide information to persons who wish to make these evaluations.
  

These conclusions are some of those reached in Statement of Financial Accounting Concepts No. 1. As the Board stated, these statements "are intended to establish the objectives and concepts that the Financial Accounting Standards Board will use in developing standards of financial accounting and reporting".9 How successful the Board will be in the approach adopted remains to be seen.