Transcript Intermediate Accounting - Mount Allison University | Homepage

Intermediate Accounting
Thomas H. Beechy
Schulich School of Business,
York University
Joan E. D. Conrod
Faculty of Management,
Dalhousie University
PowerPoint slides by:
Bruce W. MacLean,
Faculty of Management,
Dalhousie University
Copyright 1998 McGraw-Hill Ryerson Limited, Canada
home
back
next
The Environment of Accounting
Thomas H. Beechy
Schulich School of Business,
York University
Chapter
2
Joan E. D. Conrod
Faculty of Management,
Dalhousie University
PowerPoint slides by:
Bruce W. MacLean,
Faculty of Management,
Dalhousie University
Copyright 1998 McGraw-Hill Ryerson Limited, Canada
home
back
next
2
Introduction



This chapter looks at the financial
statement concepts and principles
that guide accounting choices.
These concepts and principles
underlie the exercise of professional
judgement.
It is the these sets of principles that
provide the criteria that distinguish
professional judgement from the
exercise of uninformed opinion or
bias.
Copyright 1998 McGraw-Hill Ryerson Limited, Canada
home
back
next
2
Sorting Out Accounting ‘Principles’



Underlying assumptions (or postulates) are the basic
foundation
Measurement methods (or measurement conventions)
are the various ways in which financial position and the
results of operations can be reported. These are the
accounting choices that management of every organization
must make.
Qualitative criteria (or qualitative characteristics) are the
criteria which, in conjunction with the organization’s
reporting objectives, are used to evaluate the possible
measurement options and choose the most appropriate
accounting policies for the given situation.
Copyright 1998 McGraw-Hill Ryerson Limited, Canada
home
back
next
2



Sorting Out Accounting ‘Principles’
To construct financial statements for a particular
enterprise, it is necessary:
– to establish the facts of the business and its
operating and economic environment,
– to determine the objectives of financial
reporting
– to develop the statements by using situationappropriate accounting policies to measure
the elements of the financial statements.
This process can be illustrated by the pyramid
shown in Exhibit 2-1 in the text (see next slide)
The financial statements themselves are the apex
of the process; the foundation is the objectives,
facts and constraints for the reporting enterprise.
Copyright 1998 McGraw-Hill Ryerson Limited, Canada
home
back
next
2
The AcSB’s Financial Statement
Concepts

The CICA Handbook contains a section on “Financial
Statement Concepts” (Section 1000). The purpose
and scope of this section is described as follows (with
emphases added):
– The purpose of this Section is to describe the concepts
underlying the development and use of accounting
principles in general purpose financial
statements. Such financial statements
are designed to meet the common
information needs of external users
for financial information about an entity.
[CICA 1000.01]
Copyright 1998 McGraw-Hill Ryerson Limited, Canada
home
back
next
Historical Cost
Revenues
Revenue
Recognition
FS
Expenses
Matching
Gains Relevance
Time Period
Full
Disclosure
Losses Understandability
Separate entity
Elements
Reliability
Continuity
The nature of the environment has a profound
effect on the entire
Comparability
Measurement
conceptual framework.
General
Purpose FS Proprietary approach
Objectivity
Quantitative
Unit of Measure
In
the
Canadian
economic
environment,
the production
of goods
There
are
exceptions
to
the
applicability
Public or private?
Methods
Criteria
Dollar Capital
and
services
are, Statement
to a significant
extent,
carried
out
by investor-owned
of the
Financial
Concepts
(FSC)
andNormal
conclusions.
GAAP
required?
business
entities
in the
sector and
to a lesser
FSCs
relate only
to private
the statements
themselves
notextent
otherby
sources
Audit
required?
Underlying
Assumptions
government-owned
business
entities.
Debt and
equity
markets and
FS are limited
Financial information
about
past transactions
Unqualified
opiniontoneeded?
financial
institutions
actevents
as exchange mechanisms for investment
and events
not future
Reporting
resources.
[CICA
1000.07]
However,
estimates
are
requiredConstraints
about future transactions
Assets
Liabilities
Owner’s
Equity
Facts
Nature of Business Economic environment
Objectives of Financial Reporting - (Chapter 1)
2
Professional Judgement In Accounting

In any specific situation, an accountant exercises professional
judgement about alternative measurement methods, (both
accounting policies and accounting estimates) by taking into
account several factors:
 the users of the financial statements, and
their specific information needs;
 the motivations of managers;
 the organization’s operations  e.g., the
type of ownership, the sources of financing,
the nature of its operating or earnings cycle, etc.;
 its reporting constraints, if any  e.g., audit
requirements, reporting to securities regulators,
constraints imposed by foreign owners, etc.;
Copyright 1998 McGraw-Hill Ryerson Limited, Canada
home
back
next
2
Underlying Assumptions
Time period assumption
Continuity assumption
That meaningful
information
that the assumption
enterprise
can
will continue
Proprietary
Separate entity assumption
in operation
for the foreseeable
that
the
results
of
the
enterprise’s
be assembled
and
reported
for
a
That the enterprise can be
Nominal
dollar
capital
future
operations
should
be
reported
time period Unit
that
isofless
than
the
measure
assumption
accounted maintenance
for
and reported
assumption
from
the
viewpoint
of
its owners
enterprise’s
liferesults
span. of the enterprise’s
t
hat
the
independent
owners and
thatof
theitsenterprise
has generated
operations
can meaningfully be
other
stakeholders.
a profit if its revenues are higher
measured in monetary terms.
than the historical cost of the
resources used
Copyright 1998 McGraw-Hill Ryerson Limited, Canada
home
back
next
2
Time period assumption.
 The operating results of any business enterprise cannot be
Accrual
method of accounting is required
knownare
with
certaintyrecognition
until the of
company
completed
its yet
life
Accruals
the accounting
assets and has
liabilities
that have not
span
andasceased
doing business.
been
realized
a cash flow;
to a
theseries
delayedof
recognition
costsperiods
and receipts that have been
Deferrals
Reportrefer
over
shorter oftime
realized through cash flows but have not yet contributed to the earnings process as
– one year is the standard. calendar year or fiscal year-end (low point in
expenses and revenues
business activity) could be weekly, monthly or quarterly
Sometimes a longer time period is used (mining companies)
Deferrals
Life of
Start of Entity
Entity

Time Periods
Copyright 1998 McGraw-Hill Ryerson Limited, Canada
Accruals
home
back
next
2
Separate entity assumption


Under the separate entity assumption, all accounting
and sole
records and reports are developedPartnerships
from the viewpoint
proprietorshipsa
of a single entity, whether it is a proprietorship,
partnership,
or a corporation.
Corporation
The assumption is that an individual's transactions are
distinguishable from those of the business he or she
might own.
– A corporation is an entity that is legally and for taxation
purposes quite distinct from its owners, even if the corporation
is a private family corporation or has a single shareholder.
– Partnerships and sole proprietorships do not share the legal
and tax status of separate entities; in law and in taxation, they
are viewed as an extension of their owners.
Copyright 1998 McGraw-Hill Ryerson Limited, Canada
home
back
next
Continuity assumption
2
(going-concern assumption)
The business entity is expected not to
liquidate but to continue operations for the
foreseeable
sufficient
to carry
out
If the
continuity future
of a business
enterprise
is in
contemplated
operations, contracts, and
doubt,
then many commonly-used
commitments,
andare
recover
(or use up)
its
measurement
methods
not appropriate,
(the
principle
interperiod
allocation
is rendered
assetsofand
repay its
outstanding
liabilities.
nonsensical)
 Provides a conceptual basis for

when a business is a limited-life venture,
– the historical cost concept - assumes that the
when a business is in financial difficulty and is
business’s fixed assets will be used up over their
expected to be shut down and liquidated.
life-time, which gives rise to the process of
interperiod allocation.
 classified of current or long-term assets and
liabilities
Copyright 1998 McGraw-Hill Ryerson Limited, Canada
home
back
next
2
Proprietary assumption



The proprietary concept: under this approach,
an organization’s financial
condition and results of operations
Click here
are reported from the point of view
for Details
of the owners, or proprietors in an
economic sense
The entity concept: under this approach to
accounting, the owners are just one of many
participants in the enterprise
The fund concept: under this assumption, the
basic accounting function is to trace the flow of
funds in the organization.
Copyright 1998 McGraw-Hill Ryerson Limited, Canada
home
back
next
2

Unit of measure assumption
Money is the language of accounting
– Results of a business's economic activities can be reported in terms of a
standard monetary unit throughout the financial statements.
– The common unit of measure enables dissimilar items to be aggregated
into a single total. (cost of a ton of coal + amount of an account payable)
– The unit-of-measure assumption implies:


that if it can’t be measured, it can’t be reported.
if it can’t be reported, it can’t be used for decisionmaking by external users.
– such as:



the value of customer goodwill,
the impact of operations on the environment, or
the value of the intellectual and human capital.
Copyright 1998 McGraw-Hill Ryerson Limited, Canada
home
back
next
2

Nominal dollar capital maintenance
assumption
The relative value of a currency can be measured :
 in relation to the value of other currencies, or
 in relation to the amount of goods and services
that it will buy (its purchasing power).
– currencies of different nations adjust to maintain
their relative purchasing powers
– In Canada and the United States, accounting is
performed under the assumption that every dollar
of revenue and expense has the same value

Three other alternative approaches to this problem:
 nominal dollar capital maintenance (or
maintenance of financial capital);
 constant dollar capital maintenance
 productive capacity capital maintenance
Copyright 1998 McGraw-Hill Ryerson Limited, Canada
home
back
next
2
Qualitative Criteria








Relevance
Understandability
Reliability
The Trade-off between
Cost and Benefit
Conservatism
Objectivity
Comparability
Other Trade-offs
Copyright 1998 McGraw-Hill Ryerson Limited, Canada
home
back
next
2
Criteria for Assessment of Standards
and of Accountability
Criteria that may be in
conflict with those in the
other column, or require
"trade-offs"
Relevance
Objectivity
Comparability Verifiability
Timeliness
Precision
Clarity
Completeness
or
Full Disclosure
Copyright 1998 McGraw-Hill Ryerson Limited, Canada
Criteria that
are compatible
with those in
both of the first
two columns
Representational
faithfulness
Freedom from
bias
Rationality
Nonarbitrariness
Uniformity
Constraints that may
apply against any of
the criteria in the
first three columns
Substance over form
Materiality
Cost/Benefit
effectiveness
Flexibility
Data availability
Consistency
Conservatism
home
back
next
2
Relevance
Timeliness
 Theoretically,
relevance
is the
most important
Predictive
value.
Feedback
value.
Accounting
information
Accounting
information
Accounting
should
information
qualitative
characteristic.
If accounting
should beinformation
timely if it isbe helpful
to external
should
be helpful to
is to be
of any decision
use,
it must:
to be useful to users for
makers by increasing their
external
abilitydecision makers
–
be
relevant
for
its
intended
use
making decisions. Like
to make predictions about
who
theare confirming past
make
a difference
the events.
external
decisionormakers
the news of– the
world,
outcome of to
future
predictions
making
financialmakers
reports.
stale financialwho useDecision
working
updates,
from adjustments, or
information
has less accounting
 Additional
characteristics
that
to
information that
corrections
hasrelate
to predictions
impact than
fresh
little
or no predictive value are
relevance
are:
information. Lack of merely speculating intuitively.
timeliness reduces
relevance.
Copyright 1998 McGraw-Hill Ryerson Limited, Canada
home
back
next
2
Understandability


Information must be
understandable to be useful
to users in their decision-making
Investors and creditors :
– reasonable understanding of
business and economic activities,
– some understanding of accounting
– expected to study the information
with reasonable diligence
– who lack expertise are properly advised.
Copyright 1998 McGraw-Hill Ryerson Limited, Canada
home
back
next
2
Reliability

Information is reliable if users can
depend on it as a sufficiently
accurate measure of what it is
intended to measure.

There are three components to
reliability:
– Representational faithfulness
(including substance over form)
– Verifiability
– Freedom from bias (or neutrality)
Copyright 1998 McGraw-Hill Ryerson Limited, Canada
home
back
next
2
Comparability

Comparability is a characteristic of the relationship between
two pieces of information. It enables users to identify
similarities in and differences between the information
provided by two sets of financial statements

Consistency,
– which entails using the same accounting
policies from year to year within a firm

Uniformity,
– which means that companies with
similar transactions and similar
circumstances use the same accounting treatments.
Copyright 1998 McGraw-Hill Ryerson Limited, Canada
home
back
next
2
Objectivity – the ‘Missing’ Criterion
Objectivity is one of the most-used concepts in
accounting, and yet it is not even mentioned in the
AcSB’s Financial Accounting Concepts section.
Objectivity can be viewed as being one or a
combination of the following characteristics:
 Quantifiability,
 Verifiability,
 Freedom from bias,
 Nonarbitrariness,
Quantifiability,
the ability
ability
to independent
attach
a number
toor
an
event.
The on
impact
Verifiability,
Freedom
Nonarbitrariness,
from
orbias,
the
the
theabsence
basing
of
of
of intentional
accounting
accountants
measurements
unintentional
to replicate
the of
some
events,
like
some, contingent
losses,
cannot
be measured
with
results
misstatement
observable
of an accounting
orvalues.
skewing
measurement,
of an accounting
discussed
measurement.
previously
This
asalso
a isany
a
degree
of reliability
and any attempt to measure them is said not to be
component
of reliability
objective
Copyright
1998 McGraw-Hill Ryerson Limited, Canada
back
next
home

2
Conservatism



When uncertainty exists, estimates of a
conservative nature attempt to ensure that
assets, revenues and gains are not overstated
Conversely, that liabilities, expenses and losses
are not understated.
However, conservatism does not encompass
the deliberate understatement of assets,
revenues and gains or the deliberate
overstatement of liabilities, expenses and
losses. [CICA 1000.21]
Copyright 1998 McGraw-Hill Ryerson Limited, Canada
home
back
next
2
The Trade-off between Cost and
Benefit
Examples:
 Any accounting measurement or disclosure should result
in greaterdepreciation/amortization
benefits to the users than itexpense
costs toon
prepare
calculating
the
and present.
same basis
as CCA;
 For private
companies
that
are not
bound
by the GAAP
recognizing
revenue
on the
same
basis
for accounting
as
for taxconstraint
purposes;for public companies, the cost/benefit trade-off
is a very real one.
expensing development costs and other costs that could
 In particular, if there are no external users of a private
be deferred and amortized for accounting purposes;
company’s financial statements (other than Revenue
reporting
monetary
items
that
are denominated
a
Canada),
then there
is no
benefit
to be derivedinfrom
foreignincurring
currency
at historical
exchange
higher
accounting
costs rates instead of
current rates.
Copyright 1998 McGraw-Hill Ryerson Limited, Canada
home
back
next
2
Other Trade-offs

Trade-off between qualitative characteristics,
– Reliability may have to be reduced to increase the degree of
relevance, or vice versa.




Exercise of professional judgement.
Subjectivity in the standard setting process What is relevant? and What is measurable?
The concerns of the auditing profession Emphasize verifiability.
The historical cost measurement convention often
overrides the relevance of other highly objective
measurements.
Copyright 1998 McGraw-Hill Ryerson Limited, Canada
home
back
next
Relationship between financial statements
Annual Accounting Period
19A
Jan. 1
19B
Balance
Sheet
(Begin)
Dec. 31
19B
Income
Statement
Balance
Sheet
(End)
Assets
Assets
Liabilities
Liabilities
Owner’s Equity
Net Income
Owner’s Equity
Statement of Cash Flows
Increase or Decrease in cash
19C
2
Recognition and Measurement

Elements of Financial Statements
– AcSB, an element should be included in the
accounts when
The item meets the definition of an element.
 The item has an appropriate basis of measurement, and a
reasonable estimate can be made of the amount.
 For assets and liabilities, it is probable that the economic
benefits will be received or given up.


Measurability is important.
– If an item cannot be measured, it cannot be
recognized, even if it has a high probability of being
realized.
Copyright 1998 McGraw-Hill Ryerson Limited, Canada
home
back
next
2
Balance Sheet
Elements
Assets are economic resources controlled by
an entity as a result of past transactions or
events from which future economic benefits
may be obtained
Transaction Characteristics
To qualify as assets, the resources involved
must
1. Have future economic benefits;
2. Be under the entity's current control and
3. Result from past transactions
Liabilities are obligations of an entity arising
To qualify as liabilities, obligations must:
from past transactions or events, the settlement 1. Require future transfer of assets or
of which will result in the transfer or use of
economic benefits
assets, provision of services, or other yielding 2. Be an unavoidable current obligation
of economic benefits in the future
3. Result from past transactions
Owners equity/net assets is the ownership
interest in the assets of an entity after
deducting its liabilities. While equity in total is
a residual, it includes specific categories of
items - for example, types of share capital,
other contributed capital, and retained
earnings.
Copyright 1998 McGraw-Hill Ryerson Limited, Canada
The dollar amounts reported represent the
residual interest in the assets after deducting
the liabilities. In addition, the equity element
is used to report capital transactions
Source: CICA Handbook, “Financial
Statement Concepts”, Section 1000.
home
back
next
2


Example: suppose that a company signs a
three-year contract to hire a special
consultant; the contract is non-cancelable.
Should the company recognize a liability?
The conditions for recognition do seem to be satisfied:
 the
contract will require a cash outflow over the next three years;
 there is a present obligation that is unavoidable; and
 the transaction has already occurred.
However, such a contract is not recognized in business
accounting because the consultant has not yet rendered the
services for which she was hired.
 A commitment, even if irrevocable, does not normally result in
recognition of a liability or asset.
 Therefore, the commitment would be viewed as an executory
contract  a contract wherein neither party has yet fulfilled the
Copyright
1998 McGraw-Hill Ryerson
back
next
home
requirements
of Limited,
the Canada
contract  and would not be recognized.

AcSB’s Definitions of Income Statement
2
Elements (discussed in Chapter 3)
Revenues are increases in net assets, either by way of
inflows or enhancements of assets or reductions of
from from
the ordinary
from peripheral
liabilities, resulting
the ordinary activities
of the
activities of
or incidental
enterprise.
the enterprise
 Expenses are decreases
in net. assets, transactions.
either by way of
outflows or reductions of assets or incurrences of
liabilities, resulting from an enterprise’s ordinary
Gains
Increases
in generating
revenue
or service delivery activities.
Revenues
netassets
Gains are increases in net assets from peripheral or
incidental transactions.
Decreases
in
Losses or
Expenses
 Losses are decreases
in net assets from peripheral
net assets
incidental transactions.

Copyright 1998 McGraw-Hill Ryerson Limited, Canada
home
back
next
2


Recognition, Realization, and Accrual
Recognition is the process of measuring and
including an item in the financial statements.
– The item is given a title
and a numerical value.
– Recognition applies to
all financial statement elements in
all accounting entities.
Disclosure
– (in the notes to the financial statements) is
not recognition; when a financial statement
element is recognized, it is reported on the
face of the financial statements.
Copyright 1998 McGraw-Hill Ryerson Limited, Canada
home
back
next
2
Recognition, Realization, and Accrual


Realization
– is the process of converting an asset,
liability, or commitment into a cash flow.
– A receivable is said to be realized when
it is collected;
– Revenues are realized when received;
– Expenses and liabilities are realized
when the cash payment occurs.
Once realization has occurred, recognition
must occur because there has been a cash
flow impact that cannot be ignored in the accounts.
Copyright 1998 McGraw-Hill Ryerson Limited, Canada
home
back
next
2


Recognition, Realization, and Accrual
When we recognize the effects of transactions and events
prior to their realization, we are using the accrual
concept.
– we recognize assets when we have the
right to receive their benefits, and
– we recognize liabilities when we take
on the obligation to deliver cash (or
other assets) or services in the future.
Accrual does not refer to the subsequent
transfer of amounts from the balance
sheet to the income statement, which
is a secondary form of recognition
Copyright 1998 McGraw-Hill Ryerson Limited, Canada
home
back
next
2
Recognition, Realization, and Accrual
Recognition
often occurs prior to realization. For example:
 Examples:
 An accounts receivable is recognized when a service has been
 A customer makes a deposit (or pays in advance) for
performed for a client; realization occurs when the client pays the
goods yet to be produced and delivered; since the cash
account. The offset is to recognize revenue.
has been received (realized), it must be recognized.
 A liability
forrevenue
a purchase
inventory
is recognized
when
the
Since
willofnot
yet have
been earned,
the
goods are
received;
realization
occurs when
the creditor
is paid. The
offsetting
credit
is to recognize
unearned
revenue.
offset is to recognize inventory as an asset.
– A company pays a retainer to a lawyer who will be
 The liability
purchase
of new
equipment
recognized;
the
actingfor
onathe
company’s
behalf
in the is
next
fiscal year;
liability the
is offset
an increase
in anrecognition
asset account
equipment).
cashby
outflow
triggers
of (i.e.,
a prepaid
 Unpaidexpense.
wages are accrued at the end of a fiscal period; a liability is
recognized. The liability is offset by a debit to an expense account.
Copyright 1998 McGraw-Hill Ryerson Limited, Canada
home
back
next
2
Measurement Conventions



Measurement is the process of determining the amount at
which an item is recognized in the financial statements.
Measurement methods encompass not only the process of
attaching a number to a construct but also the process of
income measurement
The process of income measurement involves not only the
initial measurement, but also the disposition of that
measurement as it moves through the financial statements.
–
–
–
–
Historical Cost Convention
Revenue Recognition Convention
Matching Convention
Full Disclosure
Copyright 1998 McGraw-Hill Ryerson Limited, Canada
home
back
next
2
Historical Cost Convention





The historical cost convention specifies that the
actual acquisition cost be used for initial accounting
recognition purposes.
The cost principle assumes that assets are acquired
in business transactions conducted at arm's length
If an asset is acquired via some means other than
cash, the cost of the asset is based on the value of the
consideration given.
Consideration is whatever the buyer gives the seller.
The cost principle provides guidance primarily at the
initial acquisition date
Copyright 1998 McGraw-Hill Ryerson Limited, Canada
home
back
next
2
Revenue Recognition Convention


The revenue recognition convention requires the
recognition and reporting of revenues when all three of
the recognition criteria  definition, measurability and
probability – are met
Traditionally, four conditions have to be met to satisfy
the revenue recognition convention:
All significant acts required of the seller have been
performed.
 Consideration is measurable.
 Collection is reasonably assured.
 The risks and rewards of ownership have passed to the
buyer.

Copyright 1998 McGraw-Hill Ryerson Limited, Canada
home
back
next
2

Matching Convention
Matching - all expenses incurred in earning revenue should
be recognized in the same period that the revenue is
recognized. For example:
 If revenue is carried over (deferred) for recognition in a future
period, any related expenses should also be carried over or
deferred, since they are incurred in earning that revenue.
 If revenue is recognized in the current period but there are
expenditures yet to be incurred in future periods, the expenses
are recognized and a liability is created (e.g., the estimated
provision for warranty costs).
 If costs are incurred to enhance the general revenue-generating
ability of the company in future periods and the future benefits
are measurable, the costs are capitalized and amortized.
Copyright 1998 McGraw-Hill Ryerson Limited, Canada
home
back
next
2
Full Disclosure


Full disclosure means that the financial statements
should report all relevant information bearing on the
economic affairs of a business enterprise.
A useful guide to deciding what to disclose is as follows:
– Disclose items not in the regular or
normal activities of the business.
– Disclose items reflecting changes
in expectations.
– Disclose that which a statute or
contract requires to be disclosed.
– Disclose new activities or major
changes in old ones.
Copyright 1998 McGraw-Hill Ryerson Limited, Canada
home
back
next
2
Making Choices In Accounting: The
Exercise Of Professional Judgement

Professional judgement permeates the work of a
professional accountant, and it involves an ability to build
accounting measurements that take into account:




the objectives of financial reporting in each particular situation,
the facts of the business environment and operations, and
the organization’s reporting constraints (if any).
Choices of accounting policies, accounting estimates, and
accounting measurement methods are then based on tests
of the validity of the underlying assumptions, followed by
an evaluation of the various possible measurement
methods with reference to the qualitative characteristics.
Copyright 1998 McGraw-Hill Ryerson Limited, Canada
home
back
next
2
SUMMARY OF KEY POINTS

Accounting “principles” consist of three different set of concepts: (1)
underlying assumptions, (2) measurement methods, and (3) qualitative
criteria.

Underlying assumptions include the basic postulates which make
accounting measurements possible (such as the separate entity assumption,
the unit of measure concept, and the time period assumption), but they also
include underlying measurement assumptions that usually, but not always,
are true in a given reporting situation. These measurement assumptions
include the going concern assumption, the proprietary assumption, and the
nominal dollar capital maintenance concept.

Qualitative criteria are the criteria which are used in conjunction with an
enterprise’s financial reporting objectives to determine the most appropriate
measurement methods to use in that particular reporting situation.
Copyright 1998 McGraw-Hill Ryerson Limited, Canada
home
back
next
2
SUMMARY OF KEY POINTS
 The most important qualitative criterion is that of relevance; relevance
should be determined with reference to the users of the financial
statements and the resultant financial reporting objectives.
 Some qualitative criteria conflict with each other. For example, the
most relevant measurement in a particular situation may not be
sufficiently objective to permit its use.
 Objectivity is a general concept that has several components, including
measurability, verifiability, freedom from bias, and reliability.
 The role of conservatism in accounting is to ensure that the
uncertainties and risks inherent in measuring the effects of any given
business situation are given adequate consideration. Conservatism
should not be used as a justification for overstating liabilities or
understating assets.
Copyright 1998 McGraw-Hill Ryerson Limited, Canada
home
back
next
2
SUMMARY OF KEY POINTS

Measurement methods are the various ways that the results of transactions
and events can be reported in the financial statements. There is a group of
widely-used measurement methods that can be called measurement
conventions, but they are not universally applicable. Measurement
conventions include historical cost, the revenue recognition convention,
matching, and full disclosure.

The elements of financial statements are the seven types of accounts that
appear on the balance sheet and income statement: assets, liabilities,
owners’ equity, revenues, expenses, gains, and losses.

Initial accounting recognition occurs when the effects or results of a
transaction or event are first measured and assigned to an account or
element. Subsequent recognition occurs when an amount previously
recognized is transferred from one element to another, such as by
recognizing an expense that previously had been recognized as an asset.
Copyright 1998 McGraw-Hill Ryerson Limited, Canada
home
back
next
2
SUMMARY OF KEY POINTS

Recognition of an asset or liability requires that three
time references be present: a future benefit or sacrifice
and a present right or obligation, arising from a past
transaction or event.

Realization occurs when a cash flow occurs. Realization
often occurs after recognition, but can never occur prior to
recognition because the cash flow forces recognition if it
has not occurred previously.

The accrual concept relates to the recognition of
receivables when the right to receive cash arises,
and to the recognition of liabilities when the obligation
is created. Accrual does not refer to subsequent
secondary recognition through interperiod allocations.
Copyright 1998 McGraw-Hill Ryerson Limited, Canada
home
back
next
2

SUMMARY OF KEY POINTS
Accounting is full of choices. This series of related decisions is what
constitutes professional judgement in accounting. The choice process
includes these elements:
– (1) financial statements are constructed from
(2) the financial statement elements that have
been recognized (3) using measurement methods
that (4) optimize the qualitative characteristics and
that (5) are based on the appropriate underlying
assumptions which reflect the organization’s
(6) reporting constraints and (7) the facts of its
business and environment, and that provide
information that (8) best satisfies the objectives
of financial reporting in any given situation.
Copyright 1998 McGraw-Hill Ryerson Limited, Canada
home
back
next