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Accounting

Principles

Second Canadian Edition


Weygandt Kieso Kimmel
Trenholm

Prepared by:
Carole Bowman, Sheridan College

CHAPTER

12
ACCOUNTING PRINCIPLES

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.

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).

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.
Users are 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.

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.
2000

2001

2003

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.
Assumptions
Going concern
Monetary unit
Economic entity
Time period

Principles
Revenue recognition
Matching
Full disclosure
Cost

Constraint
s

Cost - benefit
Materiality

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.

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.

Should not be
included in
accounting records
Should be included
in accounting records

Customer satisfaction
Percentage of
international employees
Salaries paid

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.

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
2000
QTR 1
QTR 2
QTR 3
QTR 4

2001
JAN

FEB

2003

MAR APR
MAY
JUN JUL
AUG
SEPT
OCT
NOV
DEC

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

REVENUE RECOGNITION

Revenue can be recognized:


1.
2.
3.
4.

At point of sale
During production
At completion of production
Upon collection of cash

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.

ILLUSTRATION 12-4

FORMULA TO RECOGNIZE REVENUE


IN THE
PERCENTAGE-OF-COMPLETION METHOD
Cost Incurred
(Current Period)

Percent Complete
(Current Period)

Total Estimated
Cost

Total Revenue

Percent Complete
(Current Period)

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.

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.

ILLUSTRATION 12-8

GROSS PROFIT FORMULAINSTALMENT 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

Cash Collections
from Customer

=
=

Gross Profit
Margin
Gross Profit
Recognized
during the period

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.

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.

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.

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.

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.

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.

CONCEPTUAL FRAMEWORK
-SUMMARY
Objectives of Financial Reporting
Qualitative
Characteristics of
Accounting Information

Elements of
Financial Statements

Recognition and Measurement Criteria


Assumptions

Principles

Constraints

INTERNATIONAL
ACCOUNTING STANDARDS

World markets are intertwined.


The International Accounting Standard Board
(IASB) has more than 150 member accounting
organizations representing more than 110
countries.
The IASB has issued over 40
InternationalAccounting Standards to obtain
uniformity in international accounting
practices.

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Copyright 2002 John Wiley & Sons Canada, Ltd. All rights
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