intermediate/financial accounting: recognition & measurement concepts
TRANSCRIPT
WELCOME TO OUR PRESENTATION
Presenting ByPresenting By
1) MD.Wahidul Haque 111-11-19062)Baban Acharjee 111-11-18803)Farjana Faiza 111-11-19004)Abdullah ar rafsan 111-11-18925)Mahbub Alam 111-11-19036)Atikur Rahman 111-11-1891
Financial Accounting:
Recognition and measurement concepts
ASSUMPTIONSASSUMPTIONS
1.1. Economic entityEconomic entity
2.2. Going concernGoing concern
3.3. Monetary unitMonetary unit
4.4. PeriodicityPeriodicity
PRINCIPLESPRINCIPLES
1.1. MeasurementMeasurement
2.2. Revenue recognitionRevenue recognition
3.3. Expense recognitionExpense recognition
4.4. Full disclosureFull disclosure
CONSTRAINTSCONSTRAINTS
1.1. Cost-benefitCost-benefit
2.2. MaterialityMateriality
3.3. Industry practiceIndustry practice
4.4. ConservatismConservatism
OBJECTIVESOBJECTIVES1. 1. Useful in investment Useful in investment
and credit decisionsand credit decisions2. 2. Useful in assessing Useful in assessing
future cash flowsfuture cash flows3. About enterprise 3. About enterprise
resources, claims to resources, claims to resources, and resources, and changes in themchanges in them
ELEMENTSELEMENTS
Assets, Liabilities, and EquityAssets, Liabilities, and EquityInvestments by ownersInvestments by ownersDistribution to ownersDistribution to ownersComprehensive incomeComprehensive incomeRevenues and ExpensesRevenues and ExpensesGains and LossesGains and Losses
Illustration 2-7 Conceptual Framework for Financial Reporting
First level
Second level
Third level
QUALITATIVE QUALITATIVE CHARACTERISTICSCHARACTERISTICS
RelevanceRelevance
ReliabilityReliability
ComparabilityComparability
ConsistencyConsistency
Recognition and measurement concepts
ASSUMPTIONS
PRINCIPLES
CONSTRAINTS
Assumptions
1)Economic entity
2)Going concern
3)Monetary Unit
4)Periodicity
Principals
1)Historical cost
2)Revenue recognition
3)Matching
4)Full disclosure
Constraints
1) Cost-benefit
2)Materiality
3)Industry practice
4) Conservatism
Basic Assumptions
Economic Entity AssumptionEconomic Entity Assumption Economic Entity AssumptionEconomic Entity Assumption
The economic entity can be identified with a particular unit of accountability
The activity of a business enterprise is separate and distinct from its owners
Entity’s assets and other financial elements are separate from the owner’s
The economic entity assumption is an accounting concept and not a legal construct
EXAMPLE
BMW activities
can be distinguished from those of other carmanufacturers such as Mercedes.
Going Concern AssumptionGoing Concern Assumption Going Concern AssumptionGoing Concern Assumption
The business enterprising will have a long life
The business is assumed to continue indefinitely unless terminated by owners
The basis of recoding financial elements is historical cost accounting
Liquidation accounting (based on net realizable value) is not followed unless so indicated
EXAMPLEEXAMPLEEXAMPLEEXAMPLE
The going concern assumption assumes that the enterprise will continue to operate in the foreseeable future.
Monetary Unit AssumptionMonetary Unit AssumptionMonetary Unit AssumptionMonetary Unit Assumption
Money is the common unit of measure of economic transactions
The use of monetary unit is relevant, simple, universally available, understandable and useful
Price level changes (inflation and deflation) are ignored in accounting, leading to the assumption that the dollar remains relatively stable
Customer satisfaction
Percentage of international employees
Salaries paid
Customer satisfaction
Percentage of international employees
Salaries paidShould be includedin accounting records
Should be includedin accounting records
Should not be included in accounting records
EXAMPLE
Periodicity (Time Period) AssumptionPeriodicity (Time Period) Assumption Periodicity (Time Period) AssumptionPeriodicity (Time Period) Assumption
Economic activities of an entity can be divided into artificial time periods (monthly, quarterly, yearly) for reporting purposes
The shorter the time period, the more difficult it becomes to determine the proper net income for the period
Investors usually demand that accounting information be quickly processed but the faster it is released, the more it is subject to error
EXAMPLE
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 2003
JAN FEB MAR APR MAY JUN JUL AUG SEPT OCT NOV DEC
Basic Principles
BASIC PRINCIPLES USED IN ACCOUNTING
Historical Cost PrincipleHistorical Cost PrincipleHistorical Cost PrincipleHistorical Cost Principle
Most assets and liabilities are recorded at its acquisition price
Cost has an important advantage over other valuations : it is reliable
Historical cost provides a reliable benchmark for measuring historical trends.
Fair value information may be more useful.
The current system is a“mixed attribute” incorporating historical cost, fair value, lower of cost or market, and other valuation bases
Revenue Recognition PrincipleRevenue Recognition PrincipleRevenue Recognition PrincipleRevenue Recognition Principle
Revenue is recognized when it is realized or realizable, and earned
Revenue is realized when goods or services are exchanged for cash or claims to cash
Revenue is realizable when assets received or held are readily convertible into cash or claims to cash
Revenue is earned when the entity has substantially accomplished what it must do to be entitled to the benefits represented by the revenues
Revenue Recognition PrincipleRevenue Recognition Principle Revenue Recognition PrincipleRevenue Recognition Principle
Usually, revenue is recognized at the time of sale
However, there are exceptions :
1. During Production : In long-term construction contracts, revenue is recognized periodically based on the percentage of job completed
2. End of Production (After production but before sales) : Where active markets exist for the product and there are no significant additional cost
3. Receipt of cash : Used when it is impossible to establish the revenue amount at the time of sale because of the uncertainty of collection. E.g. In installment sales methods, payment is required in periodic installments –> risk of uncollectible
EXCEPTIONSEXCEPTIONS
Timing of revenue recognition
Matching PrincipleMatching Principle Matching PrincipleMatching Principle
Efforts (expenses) are to be matched with accomplishment (revenues)
Expenses are matched to the revenues they help to generate
Costs that are related to the revenue are expensed and matched against the revenue in the period the revenue is recognized
When there is no connections between costs and revenues, an allocation of cost based on some systematic basis might be appropriate, e.g. The cost of fixed assets is allocated throughout its useful life because the asset contributes to the generation of revenue
Matching PrincipleMatching Principle Matching PrincipleMatching Principle
If the allocation method is not desirable, then the cost is expensed off immediately
Costs are generally classified into two groups :-
1. Product Costs : Material, labour and overhead attach to the product and carried into future periods if the revenue from the product is recognized in subsequent periods
2. Period Costs : Officers’ salaries and other administrative expenses are charged off immediately even though benefits associated with these costs occur in the future, because there is no direct relationship between cost and revenue
Expense Recognition
Full Disclosure PrincipleFull Disclosure Principle Full Disclosure PrincipleFull Disclosure Principle
Providing information that is of sufficient importance to influence the judgment and decisions of an informed user
Disclosure can be made : Within the main body of financial statements
- The item should meet the definition of a basic element, be measurable with sufficient certainty and be relevant and reliable
In the notes to financial statements - Generally explain the items presented in the main
body of the financial statements
As supplementary information - May include information that is high in relevance but
low in reliability, or that is helpful but not essential
Full Disclosure – Provided through financial statements, notes to the financial statements, and supplementary information.
ExampleExample
Constraints
CONSTRAINTS IN ACCOUNTING
Cost-Benefit RelationshipCost-Benefit Relationship Cost-Benefit RelationshipCost-Benefit Relationship
The cost of providing information should not outweigh the benefit derived from the information
However, costs and especially benefits are not always obvious or measurable
Sound judgment must be used in providing information
MaterialityMateriality MaterialityMateriality
Materiality refers to an item’s significance to a firm’s overall financial operations
An item must make a difference to be material and to be disclosed
It is also a matter of relative significance of the element
E.g. If the amount involved is significant compared with other revenues and expenses, assets and liabilities, or net income of the entity, then sound and acceptable standards should be allowed
Industry PracticesIndustry PracticesIndustry PracticesIndustry Practices
An entity may follow the general practices in the firm’s industry, which sometimes requires departure from basic accounting theory
If application of accounting theory results in statements that are not comparable or consistent, then industry practices must be examined for possible explanations
ConservatismConservatism ConservatismConservatism
Conservatism suggests that when in doubt, the preparer should always choose a conservative solution
This solution will be least likely to overstate assets and income
However, bear in mind that conservatism does not suggest that net assets or net income to be deliberately understated
ANY QUESTIONANY QUESTION
???
The EndThe End