Accounting Accounting PrinciplesPrinciplesSecond Canadian EditionSecond Canadian Edition

Prepared by: Carole Bowman, Sheridan College

Weygandt · Kieso · Kimmel · Trenholm

ACCOUNTING PRINCIPLESACCOUNTING PRINCIPLES

CHAPTERCHAPTER

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CONCEPTUAL FRAMEWORK CONCEPTUAL FRAMEWORK OF ACCOUNTINGOF ACCOUNTING

Generally accepted accounting principles are a 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.

The Canadian Institute of Chartered Accountants (CICA) is responsible for developing accounting principles in Canada.

CICA’S CONCEPTUAL CICA’S CONCEPTUAL FRAMEWORK FRAMEWORK

The conceptual framework consists of:– 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 OBJECTIVE OF FINANCIAL REPORTINGREPORTING

The objective of financial reporting is to provide information that is useful for decision-making

QUALITATIVE CHARACTERISTICS QUALITATIVE CHARACTERISTICS OF ACCOUNTING INFORMATIONOF 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:1. understandability2. relevance3. reliability4. comparability and consistency

UNDERSTANDABILITYUNDERSTANDABILITY

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.

RELEVANCERELEVANCE

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).

RELIABILITYRELIABILITY

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 COMPARABILITY AND CONSISTENCYCONSISTENCY

2000 2001 2003

Comparability means that the 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.

AssumptionsGoing concern Monetary unit Economic entity Time period

PrinciplesRevenue recognition Matching Full disclosure Cost

Constraints

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 RECOGNITION AND MEASUREMENT CRITERIAMEASUREMENT CRITERIA

GOING CONCERN GOING CONCERN ASSUMPTIONASSUMPTION

The going concern assumption assumes that the 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 ASSUMPTIONMONETARY UNIT ASSUMPTION

Customer satisfaction

Percentage of international employees

Salaries paid

Should be includedin accounting records

Should not be included in accounting records

ECONOMIC ENTITY ASSUMPTIONECONOMIC ENTITY ASSUMPTION

The economic entity assumption states that economic events can be identified with a particular unit of accountability.Example: Harvey’s activitiescan be distinguished fromthose of other food services such as Swiss Chalet.

TIME PERIOD ASSUMPTIONTIME 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 1QTR 2QTR 3QTR 4

2000 2001 2003JAN 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– Revenues measurable– Collection reasonably assured– Expenses determinable

REVENUE RECOGNITION PRINCIPLEREVENUE RECOGNITION PRINCIPLE

Revenue can be recognized:1. At point of sale2. During production3. At completion of production4. Upon collection of cash

REVENUE RECOGNITIONREVENUE RECOGNITION

PERCENTAGE-OF-COMPLETION PERCENTAGE-OF-COMPLETION METHOD OF REVENUE METHOD OF REVENUE

RECOGNITIONRECOGNITIONThe percentage-of-completion method

recognizes revenue and income on the basis of reasonable estimates of the project’s progress toward completion.

A project’s progress toward completion is measured by comparing the costs incurred in a year to total estimated costs of the entire project.

ILLUSTRATION ILLUSTRATION 12-412-4FORMULA TO RECOGNIZE REVENUE FORMULA TO RECOGNIZE REVENUE

IN THE IN THE PERCENTAGE-OF-COMPLETION METHODPERCENTAGE-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.

÷ =Cost Incurred

(Current Period)Total Estimated

CostPercent Complete (Current Period)

Percent Complete (Current Period) Total Revenue

Revenue Recognized

(Current Period)=

INSTALMENT METHOD OF INSTALMENT METHOD OF REVENUE RECOGNITIONREVENUE 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.

The instalment method, which uses the cash basis, is a popular approach to revenue recognition.

Under the instalment method gross profit is recognized in the period in which the cash is collected.

ILLUSTRATIONILLUSTRATION 12-812-8GROSS PROFIT FORMULA- GROSS PROFIT FORMULA-

INSTALMENT METHODINSTALMENT METHOD Under the instalment method, each cash collection from a customer consists of

1. a partial recovery of the cost of goods sold, and2. 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 PRINCIPLEMATCHING 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 PRINCIPLEMATCHING 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 PRINCIPLEMATCHING PRINCIPLE

FULL DISCLOSUREFULL DISCLOSURE PRINCIPLEPRINCIPLE 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 COST PRINCIPLE

The cost principle dictates that assets are recorded at their historic cost.

Cost is used because it is both relevant and reliable.1. Cost is relevant because it represents the 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 ACCOUNTINGCONSTRAINTS IN ACCOUNTING

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

The constraints are cost-benefit and materiality.1. Cost-benefit means that the value of information should be greater than the cost of providing it.2. Materiality relates to an item’s impact on a firm’s overall financial condition and operations.

CONCEPTUAL FRAMEWORKCONCEPTUAL FRAMEWORK-SUMMARY-SUMMARY

Objectives of Financial Reporting

Qualitative Characteristics of

Accounting Information

Elements of Financial Statements

Recognition and Measurement Criteria

Assumptions Principles Constraints

INTERNATIONAL INTERNATIONAL ACCOUNTING STANDARDSACCOUNTING 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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Copyright © 2002 John Wiley & Sons Canada, Ltd. All rights reserved. Reproduction or translation of this work beyond that permitted by CANCOPY (Canadian Reprography Collective) is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd. The purchaser may make back-up copies for his / her own use only and not for distribution or resale. The author and the publisher assume no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.