2 Rules of The Accounting "Game” The process of Accounting and bookkeeping are guided by rules of process.Why Have Rules ?All games such as football, baseball, basketball, etc. have rules.Why ?So that everyone plays the game the same way.Playing the Accounting "Game" is no different. .
3 What if owners and managers could prepare their business's financial statements the way they felt like ?If a business was wanting a loan or credit,they would have a tendency to overstatethe value of their assets and the value oftheir business.If it came to taxes (we don't like to have to pay them),let's expense and write off everything.As for measuring performance (profitability) and comparing businesses in the same industry, you'd have no idea as to who was actually doing well and who wasn't. You couldn't even compare your own business from year to year.
4 So, to put all businesses on the same playing field, the accounting profession has established some rules and guidelinesThe current accounting rules and standards are continually reviewed, studied, changed, and added to in orderto make financial presentations moreconsistent, comparable, meaningful,and informative.
5 The RulesGenerally 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, andrecognition 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-making4
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. understandability2. relevance3. reliability4. comparability and consistency5
9 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
10 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
11 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
12 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
13 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
14 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
15 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
16 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
17 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
18 REVENUE RECOGNITION PRINCIPLE The revenue recognition principle says that revenue should be recognized in the accounting period in which it is earned.Revenue can be recognized:At point of saleDuring productionAt completion of productionUpon collection of cash15
19 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.
20 FULL DISCLOSURE PRINCIPLE The full disclosure principle requires that circumstances and events that make a difference to financial statement users be disclosed.A summary of significant accounting policies is usually the first note to the financial statements.
21 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 theprice paid, the assets sacrificed, or thecommitment made at the date of acquisition.2. Cost is reliable because it is objectivelymeasurable, factual, and verifiable.
22 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 ofinformation should be greater thanthe cost of providing it.2. Materiality relates to an item’s impacton a firm’s overall financial conditionand operations.