Presentation on theme: "ACCOUNTING PRINCIPLES"— Presentation transcript:
1 ACCOUNTING PRINCIPLES CHAPTER 7ACCOUNTING PRINCIPLESSTUDY OBJECTIVESAfter studying this chapter, you should understand:GAAP & the conceptual frameworkBasic accounting principlesObjectives of financial reportingAccounting constraintsQualitative characteristics & financial statement elementsHow to analyze classifiedfinancial statementsBasic accounting assumptionsAccounting principles used in international operations
2 GAAP & CONCEPTUAL FRAMEWORK STUDY OBJECTIVE 1GAAP & CONCEPTUAL FRAMEWORKGAAP is a set of standards and rules recognized asa general guide for financial reporting supported by:SECMandates GAAPFASBDevelops GAAPCollaborate2
3 GAAP & CONCEPTUAL FRAMEWORK The FASB developed aCONCEPTUAL FRAMEWORKto resolve accounting and reporting problems.ConceptualFrameworkFinancialReportingObjectivesQualitativeCharacteristicsFinancialStatementElementsAssumptionsPrinciplesConstraints3
4 \ FINANCIAL REPORTING OBJECTIVES STUDY OBJECTIVE 2FINANCIAL REPORTING OBJECTIVESTo provide information:1Useful to those making investment and credit decisions.2Helpful in assessing future cash flows.3That identifies the economic resources, the claims to those resources, and the changes in those resources and claims.Assets – Liabilities = Stockholders’ Equity4
5 QUALITATIVE CHARACTERISTICS Useful information is: STUDY OBJECTIVE 3QUALITATIVE CHARACTERISTICSUseful information is:RELEVANTRELIABLECOMPARABLECONSISTENT5
6 RELEVANT INFORMATION: RELEVANCERELEVANT INFORMATION:Makes a difference in a decision.Has predictive value and feedback value.Is timely.6
7 RELIABILITY RELIABLE INFORMATION Is dependable and verifiable. Is free of error and bias.Is a faithful representation.Is factual.7
8 COMPARABLE INFORMATION COMPARABILITYCOMPARABLE INFORMATIONAccounting information from two similar companies should be comparable.Different companies in similar industries should use the same accounting principles.GMFORD8
9 CONSISTENT INFORMATION CONSISTENCYCONSISTENT INFORMATIONCompanies should use the same accounting principles from year to year.Changes in accounting principles must be justifiable.200020012002
11 MONETARY UNIT ASSUMPTION Only transaction data that can be expressed in terms of money be included in the accounting records.Payingan employeeHiringan employeeDo not recordRecord11
12 ECONOMIC ENTITYASSUMPTION other economic entities. BMWThe activities of theentity are to be keptseparate and distinctfrom the activitiesof the owner and allother economic entities.BenzEconomic events can be identified with a particular unit of accountability12
13 TIME PERIOD ASSUMPTION The economic life of a business can be divided into artificial time periodsQTR 1QTR 2QTR 3QTR 4JAN FEB MAR APR MAY JUN JUL AUG SEPT OCT NOV DEC13
14 GOING CONCERN ASSUMPTION The enterprise will continue in operation long enough to carry out its existing objectives.NOWFUTURE14
15 REVENUE RECOGNITION MATCHING FULL DISCLOSURE COST STUDY OBJECTIVE 5BASIC ACCOUNTING PRINCIPLESREVENUE RECOGNITIONMATCHINGFULL DISCLOSURECOSTAssets – Liabilities = Stockholders’ Equity
16 Revenue should be recognized in the REVENUE RECOGNITION PRINCIPLERevenue should be recognized in theaccounting period in which it is earned.When a sale is involved, revenue isrecognized at the point of sale.15
17 Expenses are matched with revenues in the period in which efforts MATCHING PRINCIPLEExpenses are matched with revenuesin the period in which effortsare made to generate revenues.Types of costsExpired CostsGenerate revenuesonly in the currentaccounting period.Unexpired CostsGenerate revenuesin future accountingperiods.
18 EXPENSE RECOGNITION PATTERN Operating expenses contribute to the revenues of the period but their association with revenues is less direct than for cost of goods sold.Provides No ApparentFuture BenefitsProvidesFuture BenefitCostIncurredBenefits DecreaseAssetExpense
19 FULL DISCLOSURE PRINCIPLE Requires that circumstances and events that make a differenceto financial statement users are to be disclosed in one of two places.Body/DataNotesSUMMARY OF SIGNIFICANT ACCOUNTING POLICIES USUALLY THE FIRST FOOTNOTE
20 Requires assets to be recorded at cost. COST PRINCIPLERequires assets to be recorded at cost.COSTis relevant because it represents:PRICE PAIDorASSETS SACRIFICEDCOMMITMENT MADECOSTis reliable because it is:OBJECTIVELYMEASURABLEandFACTUALVERIFIABLE
21 BASIC ACCOUNTING PRINCIPLES Revenue RecognitionMatchingCosts Matching Sales RevenueAt endof productionAt point of saleCEMENTMaterialsLaborOperating ExpensesDuringproductionAt timecash receivedRevenue should be recognized in the accounting period in which it is earned (generally at point of sale).Advertising UtilitiesDeliveryExpenses should be matched with revenuesCostFull Disclosure* Financial Statements* Balance Sheet* Income Statement* Retained EarningsStatement* Cash Flow StatementCircumstances and events that make a difference to financial statement users should be disclosed.Assets should be recorded at cost.
22 BASIC ACCOUNTING CONSTRAINTS Study Objective 6Materiality$ConservatismWhen in doubt, choose the solution that will be least likely to overstate assets and income.For small amounts, GAAPdoes not have to be followed.
23 SUMMARY OF CONCEPTUAL FRAMEWORK Objectives of Financial ReportingQualitative Characteristics of Accounting InformationElements of Financial StatementsOperating GuidelinesAssumptionsPrinciples
24 Going concern assumption REVIEW QUESTIONValuing assets at their liquidation value rather than theircost is inconsistent with which of the following:Time period assumptionMatching principleGoing concern assumptionMateriality constraintAnswer:Going concern assumptionLiquidation values would suggestthe company is going out of business.
26 Category Includes: Classified Income Statement ANALYZING CLASSIFIED FINANCIAL STATEMENTSClassified Income StatementCategoryIncludes:Revenue sectionsSales, discounts, allowancesCost of goods soldCost of items sold to produce salesOperating expensesSelling & administrative expense informationOther revenues & gainsRevenues or gains from non-operating transactionsOther expenses & lossesExpenses or losses from non-operating transactionsAlso included are tax expense and EPS
27 INCOME STATEMENT WITH TAX EXPENSE For the Year Ended December 31, 2006 Leads, IncIncome StatementFor the Year Ended December 31, 2006Sales$800,000Cost of goods sold600,000Gross profit200,000Operating expenses50,000Income from operations150,000Other revenues and gains10,000Other expenses and losses4,000Income before income taxes156,000Income tax expense (30%)46,800Net income$109,200
28 = = EARNINGS PER SHARE Net income EPS Common shares outstanding Assuming Leads, Inc. had 54,600 shares ofcommon stock outstanding, EPS would be:109,200=$2.0054,600
29 The following ratio analysis uses Genlyte data. FINANCIAL STATEMENTSGENLYTE , INC.Genlyte, Inc.Balance SheetDecember 31, 2006AssetsLiabilities & EquityCurrent Assets$156,000Current liabilities$70,000Plant & equipment74,000Long-term liabilities114,000Intangible assets14,000Stockholders’ Equity60,000Total assets$244,000Total liabilities & equityThe following ratio analysis uses Genlyte data.
30 For the Year Ended December 31, 2006 FINANCIAL STATEMENTSGENLYTE , INC.Genlyte, Inc.Income StatementFor the Year Ended December 31, 2006Sales$430,000Cost of goods sold295,000Gross profit135,000Selling and administrative expenses109,000Income from operations26,000Other expenses & losses5,000Income before income taxes21,000Income tax expense (33.3%)7,000Net income14,000Earnings per share (40,000 shares outstanding)0.35
31 Each can be evaluated by financial statement ratios ANALYZING FINANCIAL STATEMENTSThree major characteristics are evaluatedLIQUIDITYPROFITABILITYSOLVENCYEach can be evaluated by financial statement ratios
32 Current Ratio Working capital LIQUIDITYLIQUDITY RATIOS measure a company’sAbility to pay its maturing obligationsand meet unexpected needs for cash.Current RatioCurrent assets/Current liabilitiesWorking capitalCurrent assets – Current liabilities156,000/70,000 = 2.23 to 1156,000 - $70,000 = $86,000
33 ROA ROE PROFITABILITY PROFITABILITY RATIOS measure the operating success of a companyfor a given period of time.ROA(return on assets)Net Income / Total AssetsROE(return on equity)Net Income / Common Equity$14,000 / $244,000 = 5.7%$14,000 / $60,000 = 23.3%
34 DTA DTE SOLVENCY SOLVENCY RATIOS measure the ability of a company to survive over the long term.DTA(debt to total assets)Total Debt / Total AssetsDTE(debt to equity)Total Debt / Total Equity$184,000 / $244,000 = 75.4%$184,000 / $60,000 = 3.06 to 1
35 INTERNATIONAL OPERATIONS STUDY OBJECTIVE 8INTERNATIONAL OPERATIONSWorld markets are becoming increasingly intertwined.Firms that conduct operations in more than one country through subsidiaries, divisions, or branches in abroad are referred to as multinational corporations.International transactions must be translated into U.S. dollars.