3 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.2
4 CICA’S CONCEPTUAL FRAMEWORK The conceptual framework consists of:objective of financial reporting,qualitative characteristics of accounting information,elements of financial statements, andrecognition and measurement criteria (assumptions, principles, and constraints).3
5 OBJECTIVE OF FINANCIAL REPORTING The objective of financial reporting is to provide information that is useful for decision-making4
6 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. understandability2. relevance3. reliability4. comparability and consistency5
7 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.6
8 RELEVANCEAccounting 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).6
9 RELIABILITYReliability 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.7
10 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.2000200120038
11 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.AssumptionsGoing concern Monetary unit Economic entity Time periodPrinciplesRevenue recognition Matching Full disclosure CostConstraintsCost - benefit Materiality10
12 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.14
13 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.Customer satisfactionPercentage of international employeesSalaries paidShould be includedin accounting recordsShould not be included in accounting records11
14 ECONOMIC ENTITY ASSUMPTION The economic entity assumption states 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.12
15 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 yearsQTR 1QTR 2QTR 3QTR 4JAN FEB MAR APR MAY JUN JUL AUG SEPT OCT NOV DEC13
16 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 completeRevenues measurableCollection reasonably assuredExpenses determinable15
17 Revenue can be recognized: REVENUE RECOGNITIONRevenue can be recognized:1. At point of sale2. During production3. At completion of production4. Upon collection of cash15
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.16
19 ILLUSTRATION 12-4 FORMULA TO RECOGNIZE REVENUE IN THE PERCENTAGE-OF-COMPLETION METHOD Cost Incurred (Current Period)Total Estimated CostPercent Complete (Current Period)=÷Percent Complete (Current Period)Total RevenueRevenue 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.17
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.19
21 ILLUSTRATION 12-8 GROSS PROFIT FORMULA- INSTALMENT METHOD Under the instalment method, each cash collection from a customer consists of1. a partial recovery of the cost of goods sold, and2. a partial gross profit from the sale.The formula to recognize gross profit is shown below.Gross ProfitSalesRevenueGross Profit Margin=Gross Profit Recognized during the periodGross Profit MarginCash Collections from Customer=
22 MATCHING PRINCIPLEExpense 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 PRINCIPLEExpired 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.
24 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.
25 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 through1. the data in the financial statements and2. the notes that accompany the statements.A summary of significant accounting policies is usually the first note to the financial statements.
26 COST PRINCIPLEThe 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.
27 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 item’s impact on a firm’s overall financial condition and operations.
28 CONCEPTUAL FRAMEWORK -SUMMARY Objectives of Financial ReportingQualitative Characteristics of Accounting InformationElements of Financial StatementsRecognition and Measurement CriteriaAssumptionsPrinciplesConstraints
29 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.