Accounting Principles

1
CHAPTER
12
ACCOUNTING PRINCIPLES
2
CONCEPTUAL FRAMEWORK OF 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.

3
CICAS CONCEPTUAL 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).

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OBJECTIVE OF FINANCIAL REPORTING

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

5
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
• 1. understandability
• 2. relevance
• 3. reliability
• 4. comparability and consistency

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UNDERSTANDABILITY

• 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.

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RELEVANCE

• 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).

8
RELIABILITY

• 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.

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COMPARABILITY AND CONSISTENCY

• 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.

10
RECOGNITION AND MEASUREMENT CRITERIA

• 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.

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GOING CONCERN ASSUMPTION

• 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.

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MONETARY UNIT ASSUMPTION

• 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.

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ECONOMIC ENTITY ASSUMPTION

• The economic entity assumption states that
  economic events can be identified with a
  particular unit of accountability.
• Example Harveys activities can be
  distinguished from those of other food
  services such as Swiss Chalet.

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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

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REVENUE RECOGNITION PRINCIPLE

• 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

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REVENUE RECOGNITION

• Revenue can be recognized
• 1. At point of sale
• 2. During production
• 3. At completion of production
• 4. Upon collection of cash

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REVENUE RECOGNTION (WITH TERMS OF SALE)
F.O.B.
F.O.B.
Destination
Shipping Point
Ownership does not pass to the buyer until the
Ownership passes to the buyer at the
Public Carrier Co.
Public Carrier Co.
so revenue is not recognized until the goods are
delivered.
so revenue is recognized as soon as the goods
leave your business.
18
PERCENTAGE-OF-COMPLETION METHOD OF REVENUE
RECOGNITION

• The percentage-of-completion method recognizes
  revenue and income on the basis of reasonable
  estimates of the projects progress toward
  completion.
• A projects progress toward completion is
  measured by comparing the costs incurred in a
  year to total estimated costs of the entire
  project.

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ILLUSTRATION 12-4FORMULA TO RECOGNIZE REVENUE
IN THE
PERCENTAGE-OF-COMPLETION METHOD
Cost Incurred (Current Period)
Total Estimated Cost
Percent Complete (Current Period)


Percent Complete (Current Period)
Total Revenue
Revenue Recognized (Current Period)

?

• The costs incurred in the current period are then
  subtracted from the revenue recognized during the
  current period to arrive at the gross profit.

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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.
• 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.

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ILLUSTRATION 12-8GROSS 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 Recognized during the period
Gross Profit Margin
Cash Collections from Customer
?

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MATCHING PRINCIPLE

• 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.

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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.

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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.

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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.

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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.

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CONSTRAINTS 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 items impact on a
  firms overall financial condition and operations.