Unit 1 The Rules
Rules of The Accounting "Game” • The process of Accounting and bookkeeping are guided by rules of process. • Why Have Rules ? • All games such as football, baseball, basketball, etc. have rules. • Why ? • So that everyone plays the game the same way. • Playing the Accounting "Game" is no different. .
What if owners and managers could prepare their business's financial statements the way they felt like ? • If a business was wanting a loan or credit, • they would have a tendency to overstate • the value of their assets and the value of • their business. • If it came to taxes (we don't like to have to pay them), • let's expense and write off everything. • As for measuring performance (profitability) and comparing businesses in the same industry, you'd have no idea as to who was actually doing well and who wasn't. You couldn't even compare your own business from year to year.
So, to put all businesses on the same playing field, the accounting profession has established some rules and guidelines • The current accounting rules and standards are continually reviewed, studied, changed, and added to in order • to make financial presentations more • consistent, comparable, meaningful, • and informative.
The Rules • Generally accepted accounting principlesare a set of rules and practices that are recognized as a general guide for financial reporting purposes. • Generally acceptedmeans 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 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 REPORTING • The objective of financial reporting is to 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: 1. understandability 2. relevance 3. reliability 4. comparability and consistency
UNDERSTANDABILITY • Information must be understandable by its users. • Usersare assumed to have a reasonable comprehension of, and ability to study, the accounting, business, and economic concepts needed to understand the information.
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).
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.
2000 2001 2003 COMPARABILITY AND CONSISTENCY • Comparabilitymeans that the information should be comparable with accounting information about other enterprises. • Consistencymeans that the same accounting principles and methods should be used from year to year within a company.
Principles Assumptions Constraints Going concern Monetary unit Economic entity Time period Revenue recognition Matching Full disclosure Cost Cost - benefit Materiality RECOGNITION AND MEASUREMENT CRITERIA • Recognition and measurement criteriaused 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.
GOING CONCERN ASSUMPTION The going concern assumptionassumes 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.
Customer satisfaction Percentage of international employees Salaries paid Should not be included in accounting records Should be included in accounting records MONETARY UNIT ASSUMPTION • The monetary unit assumptionstates 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.
ECONOMIC ENTITY ASSUMPTION The economic entity assumptionstates that economic events can be identified with a particular unit of accountability. Example: Harvey’sactivities can be distinguished from those of other food services such as Swiss Chalet.
2000 2001 2003 QTR 1 QTR 2 QTR 3 QTR 4 JAN FEB MAR APR MAY JUN JUL AUG SEPT OCT NOV DEC TIME PERIOD ASSUMPTION The time period assumptionstates that the economic life of a business can be divided into artificial time periods. Example: months, quarters, and years
REVENUE RECOGNITION PRINCIPLE • The revenue recognition principlesays that revenue should be recognized in the accounting period in which it is earned. • Revenue can be recognized: • At point of sale • During production • At completion of production • Upon collection of cash
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.
FULL DISCLOSUREPRINCIPLE • The full disclosure principle requires that circumstances and events that make a difference to financial statement users be disclosed. • A summary of significant accounting policies is usually the first note to the financial statements.
The cost principle dictates that assets are recorded at theirhistoric 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. COST PRINCIPLE
CONSTRAINTS IN ACCOUNTING • Constraintspermit 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-benefitmeans 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.