Accounting

Principles
Second Canadian Edition
Weygandt Kieso Kimmel Trenholm

Prepared by:
Carole Bowman, Sheridan College
 CHAPTER

12

ACCOUNTING PRINCIPLES
 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.
 CICAS 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).
 OBJECTIVE OF FINANCIAL
REPORTING

The objective of financial reporting is to

provide information that is useful for
decision-making
 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
 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.
 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).
 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.
 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

 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 Principles Constraint

Going concern Revenue recognition s
Cost - benefit
Monetary unit Matching Materiality
Economic entity Full disclosure
Time period Cost
 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.
 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
Should not be
included in Percentage of
accounting records international employees
Should be included
in accounting records Salaries paid
ECONOMIC ENTITY ASSUMPTION

The economic entity assumption states that

economic events can be identified with a
particular unit of accountability.
Example: Harveys activities
can be distinguished from
those of other food services
such as Swiss Chalet.
 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

2000 2001 2003

QTR 1 JAN FEB MAR APR
QTR 2 MAY JUN JUL AUG
QTR 3 SEPT OCT NOV
QTR 4 DEC
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 complete
Revenues measurable
Collection reasonably assured
Expenses determinable
 REVENUE RECOGNITION

Revenue can be recognized:

1. At point of sale
2. During production
3. At completion of production
4. Upon collection of cash
 PERCENTAGE-OF-COMPLETION
METHOD OF REVENUE
RECOGNITION
The percentage-of-completion method
recognizes revenue and income on the
basis of reasonable estimates of the
projects progress toward completion.
A projects progress toward completion
is measured by comparing the costs
incurred in a year to total estimated
costs of the entire project.
 ILLUSTRATION 12-4
FORMULA TO RECOGNIZE REVENUE
IN THE
PERCENTAGE-OF-COMPLETION METHOD
Cost Incurred Total Estimated Percent Complete
(Current Period) Cost = (Current Period)

Revenue
Percent Complete
(Current Period) Total Revenue = 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.
 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.
 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
Gross Profit Cash Collections = Recognized
Margin from Customer
during the period
 MATCHING PRINCIPLE

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 efforts are expended to generate
revenues.
 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.
Unexpired costs are costs that will generate
revenues in future accounting periods and
are recognized as assets.
 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.
 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.
 COST PRINCIPLE

The 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.
 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 items impact on a
firms overall financial condition and operations.
CONCEPTUAL FRAMEWORK
-SUMMARY

Objectives of Financial Reporting

Qualitative
Elements of
Characteristics of
Financial Statements
Accounting Information

Recognition and Measurement Criteria

Assumptions Principles Constraints

 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.
 COPYRIGHT

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