Accounting Concepts & Assumptions

Accounting Concepts & Assumptions

Key Things To Know

Objectives of Financial Reporting:

1. Provide useful information to investors and creditors for decision making 
   (assumes users have a “reasonable understanding” of business).
2. Provide information to access the amounts, timing, and uncertainty of cash inflows and outflows.
3. Provide information about resources (assets) and claims to resources (liabilities).

Accounting Underlying Assumptions – Basis for Generally Accepted Accounting Principles (GAAP)

Entity Assumption – each business is its own “accounting” entity.

Periodicity Assumption– divide economic activities into time periods for reporting.

Going Concern Assumption – the company will remain in business and will carry out existing commitments. Assets will be used to bring future benefit and liabilities will be paid.

Monetary Assumption –  assume the dollar is stable over time. No adjustments are made for inflation or deflation.       

Accounting Principles: 

Historical Cost  –  Assets and Liabilities are recorded at cost. 

Cost is the best estimate of fair value at the time the transaction occurs.

Revenue Recognition:   Show revenues on the income statement when:

–  the earnings process is judged to be complete or virtually complete(you do not owe the customer anything else)
–  there is reasonable certainty as to the collectibility of cash  (you believe you will be paid)

Comparability –  allows users to identify similarities and differences

1) one year to the next
2) one company to another

A format for financial statements is required.  It shows trends over time.

Full Disclosure – all relevant accounting information must be disclosed to users.

1) the “notes to the financial statements” are required
2) the “notes to the financial statements” discuss details that are not shown on the financial statements

Matching – expenses incurred should be matched with revenues earned for the same period.

Accounting Constraints:

Consistency –  use the same accounting policies and procedures from one period  to the next (FASB gives choices of how things can be reported and once you choose a method you keep using it)

Conservatism  –  when estimating, present the lowest asset value, the highest liability amount, and the lowest net income position

1) recognize losses as soon as you know about them
2) recognize gains when you collect the cash

Materiality – the amount is big enough to make a difference in the decision of a reasonable person.

Cost/Benefit – the benefit must exceed the cost when gathering and presenting financial information.

Qualitative Characteristics of Financial Information:

Quantifiable – Financial Statements report only transactions that can be expressed in monetary terms.

Relevance  – capable of making a difference in a decision

1) helps the user predict the future (predictive)
2) helps the user evaluate past decisions (feedback)
3) current and available when making a decision (timeliness)

Reliability – a user can rely on it and have confidence in the information

1) represents the economic position as it really is (representational faithfulness)
2) several individuals would reach the same conclusion (verifiable)
3) doesn’t sway the users opinion, be objective (neutrality)

Secondary Qualitative Characteristics of Financial Information:

Consistency – use the same accounting policies and procedures from one period to the next
Permits valid comparisons between different periods of time

Comparability –  allows users to identify similarities and differences

1) one year to the next
2) one company to another

Elements of Financial Statements:

SFAC 6 defines 10 elements of the financial statements

Asset:

The company’s economic resources used to operate the business
(What the company HAS)

1)  Probable future economic benefit
2) Owned or controlled by the company
3) Resulting from a past transaction, something that has already occurred

The economic benefit is using the asset to generate future cash flows or the asset itself will convert to cash

Liability: 

The company’s debts and obligations (What the company OWES)

1) Probable sacrifice of a future economic benefit (an asset)
2) Present obligation to transfer assets or provide services
3) Resulting from a past transaction

You will give up an asset to pay what you owe

Equity:

Residual interest in the assets after deducting liabilities
From two sources:  Paid in Capital and Retained Earnings

Investments by Owners:

Transfer of resources to the company in exchange for ownership

Distributions to Owners: 

Decreases in equity from transfers to owners (dividends)

Revenues: 

Inflows from providing goods or services in exchange for an asset.
This is the amount the customer is expected to pay for the goods or services they received

A revenue occurs when the good/service is provided to the customer 
regardless of whether the customer has paid or not

Expenses: 

Outflows or using an asset of the company to provide goods or services
Incurred in the process of generating revenues

What it costs the company to provide the goods or services to the customer.

A service or good is provided to the company that the company will have to pay for.  The expense occurs when the company receives the service or the asset is used up, not when the company pays for the goods or service

Gains:

Increases in equity from peripheral (incidental) transactions – not part of day to day primary business activities  (sell an asset for more than cost)

Losses:

Decreases in equity from peripheral (incidental) transactions – not part of day to day primary business activities (sell an asset for less than cost)

Comprehensive Income: 

Change in equity from transactions and non owner sources

Includes all changes in equity except investments from and distributions to owners

Net Income often does not equal comprehensive income due to items that are reported directly to owner’s equity as comprehensive income that are not reported on the income statement

Net income = Revenues + Gains – Expenses – Losses