What are Statements of Financial Accounting Concepts?

Statements of Financial Accounting Concepts

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Statements of Financial Accounting Concepts

The Statements of Financial Accounting Concepts (SFAC) are a series of publications from the Financial Accounting Standards Board (FASB) that set forth fundamental objectives and concepts that the FASB uses in developing future standards of financial accounting and reporting. While not officially Generally Accepted Accounting Principles (GAAP) and thus not mandatory for external financial reporting, the SFACs guide the FASB in creating new rules and evaluating current ones.

The SFACs serve several purposes:

  • Guide Standard Setting: They provide the FASB with a foundation for setting standards and concepts to use as tools for resolving accounting and reporting questions.
  • Enhance Public Understanding: They help the public understand the nature and purposes of information supplied by financial reporting.
  • Provide a Frame of Reference: They provide a frame of reference for stakeholders to understand the FASB’s approach and principles.

Over the years, various SFACs have been issued. Some have been superseded or replaced by subsequent concepts. Each SFAC addresses different areas of accounting. For instance:

  • SFAC No. 1: “Objectives of Financial Reporting by Business Enterprises” — This concept outlines who the users of financial statements are and what information they need from those statements.
  • SFAC No. 2: “Qualitative Characteristics of Accounting Information” — This details the qualities that make accounting information useful, such as relevance and reliability.
  • SFAC No. 6: “Elements of Financial Statements” — This defines the basic elements of financial statements, like assets, liabilities, equity, revenues, and expenses.

…and so forth.

It’s important to note that while the SFACs provide important guidance and a conceptual framework for the FASB and its standard-setting process, they are not actually used to justify or support particular positions on existing financial reporting issues.

Example of Statements of Financial Accounting Concepts

Let’s delve into one of the SFACs in more detail to provide a clearer understanding: SFAC No. 2, “Qualitative Characteristics of Accounting Information.”

SFAC No. 2 identifies the characteristics that make accounting information useful to users, which primarily includes investors and creditors. It’s essential for financial information to possess certain qualitative characteristics so that it effectively serves its intended purpose.

Here are some of the primary characteristics defined in SFAC No. 2:

  • Relevance: Information should be pertinent to the decision-making needs of users. This means it should possess:
    • Predictive Value: Helps users forecast future outcomes.
    • Feedback Value: Helps users confirm or adjust past evaluations.
    • Timeliness: Information should be available to users early enough to use it in the decision-making process.
  • Reliability: Information should be dependable, representing faithfully what it purports to represent. This encompasses:
    • Verifiability: Different individuals would reach a consensus (although not necessarily complete agreement) that the information is a faithful representation.
    • Representational Faithfulness: The numbers and descriptions match what really happened or existed.
    • Neutrality: The information is free from bias.
  • Comparability: Users must be able to compare the financial statements of different companies, thus making decisions regarding where to invest, lend, etc.
  • Consistency: When the same accounting principles and methods are used from one period to the next, users can more easily predict future earnings and other attributes of a company.

To provide an example from the real world:

Imagine an investor is analyzing the financial statements of two tech companies, TechA and TechB. The investor notices that TechA’s revenue recognition policy is vastly different from TechB’s, even though both companies operate in the same sector and have similar business models.

If TechA recognizes revenue as soon as a contract is signed, while TechB recognizes revenue only when the product is delivered and accepted by the customer, comparing revenues between these two companies becomes difficult.

This difference in accounting methods affects the comparability characteristic from SFAC No. 2. For the investor to make an informed decision, it would be helpful if both companies used consistent and comparable revenue recognition policies. This is why concepts like those in SFAC No. 2 are essential for the FASB when they are crafting new accounting standards.

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