Accounting Principles - Chapter 12 Notes

Generally Accepted Accounting Principles (GAAP) are rules and practices recognized as a general guide for financial reporting.
"Generally accepted" implies substantial authoritative support.
The Canadian Institute of Chartered Accountants (CICA) is responsible for developing accounting principles in Canada.

The conceptual framework includes:
- Objective of financial reporting
- Qualitative characteristics of accounting information
- Elements of financial statements
- Recognition and measurement criteria (assumptions, principles, and constraints).

The selected accounting alternative should generate the most useful financial information for decision-making.
Useful information should possess:
1. Understandability
2. Relevance
3. Reliability
4. Comparability and consistency

Information must be understandable by its users.
Users are assumed to have a reasonable comprehension of accounting, business, and economic concepts.

Accounting information is relevant if it makes a difference in a decision.
Relevant information helps users:
- Forecast future events (predictive value)
- Confirm or correct prior expectations (feedback value).
Information must be available to decision-makers before it loses its capacity to influence decisions (timeliness).

Reliability means information is free of error and bias.
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 means information should be comparable with accounting information about other enterprises.
Consistency means the same accounting principles and methods should be used from year to year within a company.

Accountants use assumptions, principles, and constraints to solve practical problems.
Assumptions: Provide a foundation for the accounting process.
Principles: Indicate how economic events should be reported.
Constraints: Permit a company to modify GAAP without reducing the usefulness of reported information.
Assumptions: Going concern, monetary unit, economic entity, time period
Principles: Revenue recognition, matching, full disclosure, cost
Constraints: Cost-benefit, materiality

Assumes 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.

States that only transaction data capable of being expressed in terms of money should be included in accounting records.
Assumes the unit of measure () remains sufficiently stable over time.
Ignores inflationary and deflationary effects.

States that economic events can be identified with a particular unit of accountability.
Example: Separating Harvey’s activities from those of other food services.

States that the economic life of a business can be divided into artificial time periods (e.g., months, quarters, years).

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 can be recognized:
1. At point of sale
2. During production
3. At completion of production
4. Upon collection of cash

Recognizes revenue and income based on reasonable estimates of the project’s progress toward completion.
Progress is measured by comparing costs incurred in a year to total estimated costs of the entire project.
Formula to recognize revenue:
- Percent Complete (Current Period) = \frac{Cost Incurred (Current Period)}{Total Estimated Cost}
- Revenue Recognized (Current Period) = Percent Complete (Current Period) \times Total Revenue

The cash basis is used when it is difficult to determine the revenue amount at the time of a credit sale due to collection uncertainty.
The installment method uses the cash basis.
Gross profit is recognized in the period in which the cash is collected.
Each cash collection consists of:
1. A partial recovery of the cost of goods sold
2. A partial gross profit from the sale
Formula to recognize gross profit:
- Gross Profit Margin = \frac{Sales - Revenue}{Gross Profit}
- Gross Profit Recognized during the period = Gross Profit Margin \times Cash Collections from Customer$$

Expense recognition is tied to revenue recognition.
Expenses should be matched with revenues in the period in which efforts are expended to generate revenues.

Expired costs: Costs that generate revenues only in the current period; reported as operating expenses on the income statement.
Unexpired costs: Costs that will generate revenues in future accounting periods; recognized as assets.
Unexpired costs become expenses through:
1. Cost of goods sold: Costs carried as merchandise inventory are expensed when the sale occurs.
2. Operating expenses: Unexpired costs become operating expenses through use.

Requires that circumstances and events that make a difference to financial statement users be disclosed.
Compliance is achieved through:
1. The data in the financial statements
2. The notes that accompany the statements
A summary of significant accounting policies is usually the first note.

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.

Permit a company to modify GAAP without reducing the usefulness of the reported information.
Constraints: Cost-benefit and materiality.
1. Cost-benefit: 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.

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