Accounting principles chapter 12

CICA’S CONCEPTUAL FRAMEWORK – objective of financial reporting, – qualitative characteristics of accounting information, – elements of financial statements, and – recognition and measu

Accounting Principles

Second Canadian Edition

Prepared by:

Carole Bowman, Sheridan College

Weygandt · Kieso · Kimmel ·

Trenholm

ACCOUNTING PRINCIPLES

CHAPTER

12

CONCEPTUAL FRAMEWORK

OF ACCOUNTING

set of rules and practices that are recognized as a general guide for financial reporting purposes.

 Generally accepted means that these principles

must have substantial authoritative support

developing accounting principles in Canada.

CICA’S CONCEPTUAL

FRAMEWORK

– objective of financial reporting,

– qualitative characteristics of accounting

information,

– elements of financial statements, and

– recognition and measurement criteria

(assumptions, principles, and constraints).

OBJECTIVE OF FINANCIAL

REPORTING

provide information that is useful for

decision-making

QUALITATIVE CHARACTERISTICS

OF ACCOUNTING INFORMATION

 The accounting alternative selected should be

one that generates the most useful financial information for decision making.

 To be useful, information should possess the

following qualitative characteristics:

 Information must be understandable by its

users.

 Users are assumed to have a reasonable

comprehension of, and ability to study, the accounting, business, and economic

concepts needed to understand the

information.

 Accounting information is relevant if it

makes a difference in a decision.

 Relevant information helps users forecast

future events ( predictive value ), or

it confirms or corrects prior expectations ( feedback value ).

 Information must be available to

decision makers before it loses

its capacity to influence their

decisions ( timeliness ).

 Reliability of information means that the

information is free of error and bias – it

can be depended on.

 To be reliable, accounting information

must be verifiable – there must be proof

that it is free of error and bias.

 The information must be a faithful

representation of what it purports to be – it must be factual.

COMPARABILITY AND

CONSISTENCY

 Comparability means that t he information

should be comparable with accounting

information about other enterprises.

 Consistency means that the same accounting

principles and methods should be used from year to year within a company.

s

Cost - benefit Materiality

 Recognition and measurement criteria used by accountants to solve practical problems include assumptions, principles , and

constraints

 Assumptions provide a foundation for the accounting process.

 Principles indicate how economic events should be reported in the accounting process.

 Constraints permit a company to modify generally accepted accounting principles without reducing the usefulness of the reported information.

RECOGNITION AND MEASUREMENT CRITERIA

GOING CONCERN

ASSUMPTION

enterprise will continue to operate in the

foreseeable future.

Implications : capital assets are recorded at cost instead of liquidation value, amortization is used, items are labeled as current or non-current.

 The monetary unit assumption states that only transaction data capable of being expressed in terms of money should be included in the

accounting records of the economic entity.

 Also assumes unit of measure ($) remains

sufficiently stable over time Ignores inflationary and deflationary effects.

MONETARY UNIT ASSUMPTION

Customer satisfaction

Percentage of international employees

Salaries paid

Customer satisfaction

Percentage of international employees

ECONOMIC ENTITY ASSUMPTION

The economic entity assumption states that economic events can be identified with a

particular unit of accountability.

Example: Harvey’s activities

can be distinguished from

those of other food services

such as Swiss Chalet

TIME PERIOD ASSUMPTION

The time period assumption states that the economic life of a business can be divided into artificial time periods

Example: months, quarters, and years

QTR 1 QTR 2 QTR 3 QTR 4

2000 2001 2003

JAN FEB MAR APR MAY JUN JUL AUG SEPT OCT NOV DEC

 The revenue recognition principle says

that revenue should be recognized in the accounting period in which it is earned

– Production/sales essentially complete

 Revenue can be recognized:

PERCENTAGE-OF-COMPLETION

METHOD OF REVENUE

RECOGNITION

recognizes revenue and income on the

basis of reasonable estimates of the

project’s progress toward completion.

is measured by comparing the costs

incurred in a year to total estimated costs

of the entire project.

ILLUSTRATION 12-4

FORMULA TO RECOGNIZE REVENUE

IN THE PERCENTAGE-OF-COMPLETION METHOD

The costs incurred in the current period are then

subtracted from the revenue recognized during the

current period to arrive at the gross profit.

The costs incurred in the current period are then

current period to arrive at the gross profit

Percent Complete

(Current Period) Total Revenue

Revenue Recognized (Current Period)

=

×

INSTALMENT METHOD OF REVENUE RECOGNITION

 The cash basis is generally used only when it is difficult to determine the revenue amount at the time of a credit sale because collection is so uncertain.

basis, is a popular approach to revenue

recognition.

recognized in the period in which the cash is collected.

ILLUSTRATION 12-8

GROSS PROFIT FORMULA-

INSTALMENT METHOD

 Under the instalment method , each cash collection

from a customer consists of

1 a partial recovery of the cost of goods sold, and

2 a partial gross profit from the sale.

 The formula to recognize gross profit is shown below.

Sales Revenue

Gross Profit Margin Gross Profit

Gross Profit

Margin

Cash Collections from Customer

Gross Profit Recognized during the period

÷

×

=

=

 Expense recognition is traditionally tied to

revenue recognition.

 This practice – referred to as the matching

principle – dictates that expenses be

matched with revenues in the period in

which efforts are expended to generate

revenues.

MATCHING PRINCIPLE

 Expired costs are costs that will generate

revenues only in the current period and are therefore reported as operating

expenses on the income statement.

 Unexpired costs are costs that will

generate revenues in future accounting periods and are recognized as assets

MATCHING PRINCIPLE

Unexpired costs become expenses through:

1.Cost of goods sold – Costs carried as

merchandise inventory are expensed as

cost of goods sold in the period when the sale occurs – so there is a direct matching of

expenses with revenues.

2.Operating expenses – Unexpired costs

become operating expenses through use or consumption or through the passage of time

MATCHING PRINCIPLE

FULL DISCLOSURE PRINCIPLE

 The full disclosure principle requires that

circumstances and events that make a

difference to financial statement users be

disclosed.

 Compliance with the full disclosure principle

is accomplished through

1 the data in the financial statements and

2 the notes that accompany the statements.

 A summary of significant accounting policies

is usually the first note to the financial

statements.

COST PRINCIPLE

 The cost principle dictates that assets are

reliable.

price paid, the assets sacrificed, or the

commitment made at the date of acquisition.

2 Cost is reliable because it is objectively

measurable, factual, and verifiable.

CONSTRAINTS IN ACCOUNTING

generally accepted accounting principles without reducing the usefulness of the reported

information.

 The constraints are cost-benefit and materiality.

information should be greater than the cost of providing it.

firm’s overall financial condition and operations.

Recognition and Measurement Criteria

Assumptions Principles Constraints

INTERNATIONAL ACCOUNTING STANDARDS

 World markets are intertwined

 The International Accounting Standard Board

(IASB) has more than 150 member accounting organizations representing more than 110

countries.

 The IASB has issued over 40

InternationalAccounting Standards to obtain

uniformity in international accounting

practices.

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