CHAPTER

1. CHAPTER 12 ACCOUNTING PRINCIPLES

2. CONCEPTUAL FRAMEWORK OF ACCOUNTING • 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.

3. 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).

4. 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

6. 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.

7. 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.

9. 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.

10. 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.

11. 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.

12. 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.

13. ECONOMIC ENTITY ASSUMPTION The economic entity assumptionstates that economic events can be identified with a particular unit of accountability. Example: Harvey’s activities can be distinguished from those of other food services such as Swiss Chalet.

14. 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

15. REVENUE RECOGNITION PRINCIPLE • The revenue recognition principlesays 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

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

17. Seller Seller Buyer Buyer 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 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.

19. ILLUSTRATION 12-4FORMULA TO RECOGNIZE REVENUE IN THE PERCENTAGE-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 Cost Percent Complete (Current Period) = ÷ Percent Complete (Current Period) Total Revenue Revenue Recognized (Current Period) = 

20. 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.

21. ILLUSTRATION12-8GROSS 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. Gross Profit Sales Revenue Gross Profit Margin  = Gross Profit Recognized during the period Gross Profit Margin Cash Collections from Customer  =

22. 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.

23. MATCHING PRINCIPLE • Expired costsare costs that will generate revenues only in the current period and are therefore reported as operating expenses on the income statement. • Unexpired costsare costs that will generate revenues in future accounting periods and are recognized as assets.

24. MATCHING PRINCIPLE Unexpired costsbecome 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 expensesthrough use or consumption or through the passage of time.

25. FULL DISCLOSUREPRINCIPLE • 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.

26. COST PRINCIPLE • 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.

27. 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.