1. ACCOUNTING PRINCIPLES
CHAPTER 11
ACCOUNTING PRINCIPLES

2. Agenda Learning goals Vocabulary Conceptual framework of accounting
Characteristics of accounting information
Accounting principle assumptions
Accounting Principles
Constraints in Accounting

3. Learning goals Describe the conceptual framework of accounting
Identify and apply the basic assumption used by accountants
Identify and apply the basic principles of accounting
Identify and apply the constraints in accounting

4. Vocabulary Comparability Objective of financial reporting
Conceptual framework of accounting
Objectivity
Percentage-of-completion
Consistency
Cost-benefit constraint
Point of sale
Full disclosure principle
Relevance
Reliability
Materiality constraint
Understandability

5. 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

6. 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). 3

7. OBJECTIVE OF FINANCIAL REPORTING
The objective of financial reporting is to provide information that is useful for decision-making 4

8. 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 5

9. UNDERSTANDABILITY Information must be understandable by its users.
Main two external users are investors and creditors
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

10. 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). 6

11. 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.
Verifiable, faithful and representation are called objectivity 7

12. RELIABILITY
Objectivity means that two individuals, each working independently, can review the same information and reach the same results or similar conclusions.
Conservatism in accounting means that when making financial statements, companies need to choose a method that is less likely to overstate the assets and income

13. 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 8

14. 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
Constraints
Cost - benefit Materiality 10

15. 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

16. 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 satisfaction
Percentage of international employees
Salaries paid
Should be included
in accounting records
Should not be included in accounting records 11

17. ECONOMIC ENTITY ASSUMPTION
The economic entity assumption activities of a unit or organization in society are kept separate and distinct from other entities and owner
Example: Mineral Water activities can be distinguished from those of the parent company Coca Cola. 12

18. 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
QTR 1
QTR 2
QTR 3
QTR 4
JAN FEB MAR APR MAY JUN JUL AUG SEPT OCT NOV DEC 13

19. Revenue Recognition Principle
Revenue should be recognized in the accounting period in which it is earned
Specifically, revenue should be recognized when all of these guidelines are met:
Evidence of arrangement between two parties
Delivery occurred or services provided
Seller’s price is fixed or can be determined
Cash collection is reasonably certain 15

20. Revenue can be recognized:
REVENUE RECOGNITION
Revenue can be recognized:
1. At point of sale
2. During production
3. At completion of production
4. Upon collection of cash 15

21. POINT OF SALE
When the customer pays the cash and takes the merchandise.
Cash XXXX
Sales Revenue XXX
When the customer bought the product on credit
Accounts Receivable XXXX
Sales Revenue XXXX

22. DURING PRODUCTION
In certain cases, revenue can be recognized before delivery has occurred or the service has been fully provided. For example law or accounting firm that provides services for a client over serval months-how do they recognize revenue? Answer: The client is billed monthly for service provided

23. Revenue Recognition: During Production
Percentage-of-completion method recognizes revenue on long-term projects based on periodic estimates of the progress to completion
Progress to completion is determining by comparing the costs incurred to date to total cost:
Costs Incurred (Current Period)
Total Estimated Cost
Percent Complete (Current Period) ÷ =
Percent Complete (Current Period)
Total Revenue
Revenue Recognized (Current Period) x =

25. Revenue Recognition During Production: Revision of Estimate
Costs Incurred (To Date)
Total Estimated Cost
Percent Complete (To Date) ÷ =
Percent Complete (To Date)
Total Revenue x =
Revised Revenue _
Revenue Recognized Previously
Revenue Recognized (Current Period)
Revised Revenue =
When estimated project costs are revised, the percentage complete is also revised by using costs incurred to date rather than per period
A revised revenue to date is then calculated and previously recognized revenue subtracted to determine the revenue for the current period

27. REVENUE RECOGNITION COLLECTION OF CASH
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

28. ILLUSTRATION 12-8 GROSS 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
Cash Collections from Customer 
Gross Profit Margin =

29. Example
Saskatchewan farm machinery dealer has instalment sales of $600,000, and collection is uncertain. The dealer’s cost of goods sold on these instalment sales is $420,000. total gross profit is $180,000 = $600,000-$420,000.
$180,000/$600,000 = 30% gross profit margin
Instalment sales are: 1st year $280,000, 2nd $200,000, 3rd $120,000.
Year
Cash Collections from Customers
Gross Profit Margin
Gross Profit
2013
$280,000
30%
$84,000
2014
200,000
60,000
2015
120,000
36,000
Total
$600,000
$180,000

30. Revenue Recognition: Completion of Production
Revenue, expenses and gross profit not recognized until completion of project
Used when costs cannot be reliably estimated
More reliable results than percentage-of-completion method
As costs are known instead of estimated
Information is not as relevant or timely
Not reported until end of contract
Earnings are distorted over life of project

31. MATCHING PRINCIPLE (Expense Recognition)
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 those expenses helped to generate revenue.

32. 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. Or a direct relationship to revenue is hard to prove
Salaries
Unexpired costs are costs that will generate revenues in future accounting periods and are recognized as assets.
Such as machinery
Are depreciated over the life of the asset

33. 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.

34. Cost Principle Cost is used because it is:
Requires assets to be recorded at cost
Cost is used because it is:
Relevant: represents the price paid, assets sacrificed or the commitment made at the date of acquisition
Reliable: objectively measurable, factual and verifiable
CICA has moved to a modified cost model for some assets
Certain securities: at market value
Merchandise inventory: lower of cost or market
Long-lived assets: Market if permanent decline in value

35. 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.
Cost-benefit means that the value of information should be greater than the cost of providing it.
Giving more information increases costs, and the benefits of giving this information may be less than the cost sin some cases.
Materiality relates to an item’s impact on a firm’s overall financial condition and operations
If an item will not make a difference in decision-making, it is immaterial and GAAP does not have to be followed

36. Homework
P588 #1-10
BE11-2, 11-4, 11-5