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Accounting basis
Lecture 2Lecture 2
ACCOUNTING PRINCIPLES
Accounting principlesg p pRevenue and Expense
CONCEPTUAL FRAMEWORK OF ACCOUNTINGACCOUNTING
Generally accepted accounting principles y p g p pset of standards and rules that are recognized as a general guide for financial reporting
Financial Accounting Standards Board (FASB)Financial Accounting Standards Board (FASB) and Securities and Exchange Commission (SEC)The FASB has the responsibility for developingThe FASB has the responsibility for developing accounting principles.
ACCOUNTING INFORMATIONMUST BE USEFUL
T b f l i f ti h ldTo be useful, information should possess the following qualitative characteristics:1 relevance2 reliabilityy3 comparability4 consistency4 consistency
RELEVANCE
Accounting information has relevance if it makes a difference in a decision.Relevant information helps users forecast future events (predictive value), or it confirms or corrects prior expectations (f db k l )(feedback value).
RELIABILITY
R li bili f i f i h hReliability of information means that the information is free of error .To be reliable, accounting information must be verifiable.
COMPARABILITY AND CONSISTENCYCOMPARABILITY AND CONSISTENCY
Comparability means that the information should beComparability means that the information should be comparable with accounting information about other enterprises.C i i i iConsistency means that the same accounting principles and methods should be used from year to year within a company.
2005 2006 20072005 2006 2007
CHARACTERISTICS OF USEFUL INFORMATIONUSEFUL INFORMATION
THE OPERATING GUIDELINES OF ACCOUNTINGACCOUNTING
Operating guidelines are classified as assumptions, principles and constraintsprinciples, and constraints.Assumptions provide a foundation for the accounting process.Principles indicate how transactions and other economic events should be recorded.Constraints on the accounting process allow for a relaxation of
Assumptions Principl Constrai
Constraints on the accounting process allow for a relaxation of the principles under certain circumstances.
Monetary unit Economic entity Time period
esRevenue recognition Matching
ntsMateriality Conservatism
Time period Going concern Full disclosure
Cost
ASSUMPTIONS USED IN ACCOUNTING
ASSUMPTIONSMonetary unit assumption:
only transaction data expressed in terms of money can beonly transaction data expressed in terms of money can be included in the accounting records
Example: employee satisfaction and percent of international employees are not transactions that should be included in the financial records.
Employee Satisfaction
Percentage of International Employees
S l i id
Should be includedin accounting Salaries paidccou grecords
ECONOMIC ENTITY ASSUMPTION
Activities of the entity kept separateActivities of the entity kept separateand distinct from the activities of the owner
d ll th i titiand all other economic entities.Example: BMW activities can be
di ti i h d f th f thdistinguished from those of othercar manufacturers such as Mercedes.
THE ENTITY CONCEPT EXAMPLE
Assume that John decides to open up a gas station p p gand coffee shop.
The gas station made Revenues 250,000 in profits, while the coffee shop lost Revenues 50,000.
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THE ENTITY CONCEPT EXAMPLE
How much money did John make?yAt a first glance, we would assume that John made Revenues 200,000.However, by applying the entity concept we realize that the gas station made Revenues 250,000 while the coffee shop lost Revenues 50,000.coffee shop lost Revenues 50,000.
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GOING CONCERN ASSUMPTIONASSUMPTION
The entity will continueyto operate in the future.
TIME PERIOD PRINCIPLE
For reporting purposes an For reporting purposes, an organization’s life can be divided i t t ti i dinto separate accounting periods
months, quarters, years etcyears, etc.
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THE ACCOUNTING PERIOD
Exh.3.1
AnnualAnnual
1 21 2Semiannual
1 2 3 4Quarter
1 2 3 4 5 6 7 8 9 10 11 12
MonthMonth
REVENUE RECOGNITION PRINCIPLE
Revenue is generally recognized Revenue is generally recognized At the time services are performed; orp ;
When goods are sold and delivered to ta customer.
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REVENUE PRINCIPLE
Air & SeaAir & Sea Air & SeaTravel, Inc.
April 2
Air & SeaTravel, Inc.
March 12I plan to have you
make my travelarrangements.
The client has taken a trip arranged bySituation 2
The client has taken a trip arranged bySituation 1
No transaction has occurred.19
p g yp g yAir & Sea Travel. – Record Revenue
No transaction has occurred.– Do Not Record Revenue
THE MATCHING PRINCIPLE
The matching principle requires The matching principle requires that all expenses incurred to
t th i d i generate the revenues recognized in an accounting period be matchedwith those revenues.
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THE MATCHING PRINCIPLE
Another view Another view . . .Let the expense follow the revenue.
First the revenue . . .
Th th Then the expense.
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GAAP RELATIONSHIPS IN REVENUE AND EXPENSE RECOGNITIONAND EXPENSE RECOGNITION
Time-Period AssumptionTime Period Assumption
Economic life of businesscan be divided into
artificial time periods
Revenue-Recognition Principle Matching PrinciplePrinciple
R i d i
Matching Principle
Expenses matched with Revenue recognized in the accounting period in
which it is earned
prevenues
in the same period when efforts are expended to
generate revenues
Full Disclosure PrincipleFull Disclosure Principle
Illustration 1-14
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COST PRINCIPLE
The cost principle dictates that assets be recorded at their costrecorded at their cost.
Cost= Purchase price + Preparing expenses
BASIC PRINCIPLES USED IN ACCOUNTINGBASIC PRINCIPLES USED IN ACCOUNTING
CONSTRAINTS IN ACCOUNTINGCONSTRAINTS IN ACCOUNTING
Materiality ConventionMateriality ConventionA financial statement item is material if its omission or misstatement would tend to mislead the reader of or misstatement would tend to mislead the reader of the financial statements under consideration
Materiality often depends on the size of the organization –what is material to one company might not be material to what is material to one company might not be material to another company.
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DUAL ASPECT CONCEPT
Accounting information is based on the double entry g ysystem.Under this system, the two-sided effect of a transaction is recorded in the appropriate accounts.transaction is recorded in the appropriate accounts.
ASSETS = LIABILITIES + OWNER’S EQUITYThe Accounting Equation
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REVENUE AND EXPENSES
REVENUES are inflows of assets in exchange for products and g pservices provided to customer as part of a company’s primary operations.
EXPENSES tfl f th i f t f EXPENSES are outflows of the using up of assets from providing products and services to customer.
Profit= Revenue - ExpensesProfit Revenue Expenses
Revenue Accrual Basis Recognition Accrual Basis Accounting
M t hi Matching Principle
Yikes!! What is Accrual
Basis Accounting?Accounting?
ACCRUAL BASIS ACCOUNTING
Revenues are recognized (recorded) when earned without regard to when when earned, without regard to when cash is received;
Expenses are recorded as incurred without regard to when they are without regard to when they are paid.
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96 97 98 99 00 01 02 03 04 05ity
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n96 97 98 99 00 01 02 03 04 05
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Per
Ass
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How do we recognize revenues?⇒ The Revenue Recognition ⇒
PrincipleHow do we recognize expenses?
⇒ The Matching Principle
Accrual Basis Accounting
Bertha are Bertha, are there any other
bases for bases for accounting?
Yikes! I don’t know Claude We know Claude. We
probably better ask the professor!the professor!
CASH BASIS ACCOUNTING
With the cash basis With the cash basis . . .
Revenues are recognized in the period Reve ues a e ecog ed t e pe od cash is received; and
Expenses are recognized in the period when cash is paid out.
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Bertha are Bertha, are there any other
bases for bases for accounting?
Yikes! I don’t know Claude We know Claude. We
probably better ask the professor!the professor!
MODIFIED CASH BASIS ACCOUNTING
With the Modified Cash Basis . . .Current period revenues and expenses are treated exactly as in the cash basis;
Expenses covering more than one accounting period are allocated over the accounting period are allocated over the useful life of the asset.
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