Date of this Version
My last Cornhusker Economics article, Accounting Assumptions and the Farm Business (10-16-19) set the foundation for a specific evaluation of the conceptual framework accrual accounting offers the farm or ranch manager. The article addressed cash accounting and hinted at its shortfalls which were rectified by accrual accounting. This article will explain conceptual frameworks, and two accrual accounting principles; namely the revenue recognition principle and the matching principle.
During one of my graduate school experiences, I encountered a professor who seemed to be in love with conceptual frameworks. I chose a framework and tried to use it as instructed, but it wasn’t until many years later that I fully understood the usefulness of a conceptual framework. A conceptual framework is like an algorithm you use to make a choice. Imagine going to a Mexican Restaurant where there is a menu with literally hundreds of choices. You may face bounded rationality, or “paralysis by analysis.” To make up your mind, you may need to set up a process. The process could be as follows: first, you want something with carne asada (steak). Second, you don’t want anything deep-fried, and finally, you prefer flour tortillas to corn. Once these limitations are made, your choices are pared to a few choices. With less than ten meal choices to choose from, you are no longer afflicted with “paralysis by analysis.”
A conceptual framework gives the decision maker a well-established system for evaluation and decision- making. It also eliminates “noise” in the process and may even force the decision maker to set aside preconceived notions. Accrual accounting and generally accepted accounting principles (GAAP) provide this system to track economic and financial transactions, compile results, and make decisions with a focus on profit. Two main principles should unlock how the framework does this: the revenue recognition principle, and the matching principle.