The importance of establishing a document such as the Saab’s Framework is that this material helps standard setters when setting new standards or evaluating old ones, and also helps those toeing to (l) provide the most useful intimation to financial statement users, (2) understand and interpret standards, (3) set policy in areas where there are no specific standards, or (4) interpret information prepared in conformity with the concepts. 3. Ethical professional judgment is important in accounting because of the pervasiveness of choice in accounting policy and estimates.
The credibility of accounting information rests on appropriate judgment, applied to be fair to all stakeholders. 4. Underlying assumptions include: I. Time-period-?financial information can be reported over a series Of time spans shorter than the total life of the enterprise. . Separate-entity-?financial reports relate to the activities of the business enterprise separate from its owners. 3. Continuity-?the business entity will continue in operations for the foreseeable future (going concern assumption). 4. Proprietary approach-?results are reported from the perspective of the owners, who hold residual return and risk. . Unit-of-measure-?results can be meaningfully expressed in monetary terns. 6. Nominal dollar financial capital maintenance-?profits are earned after historical cost is recovered; neither general inflation nor specific changing prices re considered. S. The time-period assumption requires accruals and deferrals in accounting because cash transactions are not always completed in the accounting period to which the underlying transaction relates. Accruals and deferrals move income recognition to the year to which they relate.
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Accruals record revenues and expenses for Vichy there have as yet been no cash transaction; deferrals delay recognition of revenues and expenses. 6. The continuity assumption justifies the use of historical cost to record assets, because the cost Will be recovered over the assets’ economic life in operations. If this assumption is not valid, assets should be valued at net recoverable amounts. 7. Owners are viewed as the residual risk-takers in the proprietary view; they receive the residual profit or loss, after all other claims are met.
Under the entity view, the shareholders are only one of several stakeholders in the financial success of an entity. B. Inflation is a major factor when dealing with the nominal dollar financial capital maintenance assumption. This presumes that income has been earned when the financial capital invested in an item, not adjusted for inflation, has en recouped The stable dollar assumptions is made. For example, if an item bought for $10 is sold for $14,SO, SO,SO of income is earned. But if invested capital, $10, has been eroded by inflation, then income is overstated.
If inflation had been during the holding period, the entity should retain $11 ($10 x 1. 10) and only consider $3. 50 ($14. 50 – $11. 00) income. This ovule be an application of constant dollar financial capital maintenance. G. Financial capital maintenance is the concept that residual (and distributable) income remains only after preserving financial capital; the closing amount of net sets must exceed the amount at the Start before net income is present. In contrast, physical capital maintenance is the concept that residual income results only after preserving physical capital or productive capacity.
The difference be,even the two concepts relates to the amount of income earned through a given transaction. For example, if an item bought for 510 is sold for $14. 50. SO. 50 of income is earned under financial capital (measured in nominal dollars). Taut if it would cost $12 to replace the item, then income is only $14. 50 – ASS = SO,50. The entity must retain ASS. O in order to replace its physical opacity. 10. Three measures to income: a. Nominal dollar financial capital maintenance: 51,500 – 51,000 = $500. Income is earned as long as the original investment, $1 ,OHO, is retained. . Constant dollar financial capital maintenance: SSL ,SO -? (51,000 x I ,04) = $460. Income is earned as long as the inflation-adjusted original investment, $1,040, is retained. C. Physical capital maintenance: IS,SOC -? $380. Income is earned as long as the amount need for (physical capital) inventory replacement value is retained. II The two fundamental characteristics of accounting information are: (I) Relevance-?accounting measurements must be useful to the needs of financial statement users for making decisions. 2) Representational faithfulness-? accounting measurements must be reasonably accurate measures of what they purport to measure, Without out bias. 12. TO be relevant, information must be presented in a timely fashion. However, in many instances, accuracy (i. E. , representational faithfulness) can be improved With the passage of time when the ultimate outcomes Of year-end balances (such as accounts receivable, inventory, contingent liabilities, etc. ) become known. Such a delay makes the information less relevant, however, because it comes too late for effective decision-making by users. 13. The statement is not true.
Accounting measures complex economic phenomena and the results cannot be understood unless the financial statement user is reasonably knowledgeable about (1) business and economic activities and (2) accounting concepts and measurement methods. Users who are not sophisticated or knowledgeable about accounting, they are expected to hire experts who will provide interpretation and advice. 14 Comparability is the ability to ascertain differences and similarities between woo pieces of information. Consistency eliminates differences between years, as it requires entities to use the same policies from year to year. Uniformity eliminates differences between companies, as it requires different companies to use the same policies for similar transactions, if all circumstances are similar. 15. When evaluating cost/benefit effectiveness, costs refer to the costs to prepare the information, and also the costs Of, for example, making information available to the general public, which would include competitors. Benefits are felt by the user groups, in the form Of ‘better’ decisions. The entity participates in these decisions only indirectly, through a ‘more accurate’ share price or loan cost. 6. The definitions of assets and liabilities embody three components and three time frames: (a) Economic benefits must be received or given up in the future. (b) The rights (obligations) to (for) economic benefits must be clear in the present, (c) The asset or liability must be the result to a past event. 1 IA revenue is derived from ordinary business activities of the enterprise; a gain arises from peripheral or incidental transactions or events, 18, Recognition means recording a transaction or event in the books, while legalization means cash flow.
Realization always triggers simultaneous recognition because cash transactions require immediate recognition in the accounts. I % Revenue can be recognized when: all significant acts required of the seller have been performed, and the rests and rewards of ownership hue been passed to and accepted by the buyer; the amount of consideration is measurable; and collection Of the revenue is reasonably assured. 20. Ethical professional judgment is a necessary element in the process Of selecting accounting policies.
It involves the ability to weigh the objectives of uncial reporting in a given situation, the facts Of the business environment and operations, the organization’s reporting constraints, blended with appropriate reference to qualitative criteria. Cases Assignment 2-10 (WEB) Issue Correctness Principle Comment Correct Separate-entity Does not always correspond to the legal entity. Incorrect Representational faithfulness (Substance over form) Transactions must be analyzed to see if the recorded elements are true to the nature of the transaction. Does what is recorded convey substance?
If not, substance should be reflected in the financial statements. 3. Matching Comparability (lack thereof! ) Companies must trade off what they consider to he the best accounting principle against comparative industry practice; this is acceptable. 4. Full disclosure Too much detail is as harmful as not enough detail-?GAP requires full disclosure but excessive detail obscures more significant information. 5. Net asset principle If inventory cost is higher than its recoverable value, the inventory value must be written down to LLC to avoid overstating net assets’ future benefit. . Historical cost measurement This principle applies to most transactions and to the SEEP as well as the income tenement. 7. Revenue recognition Revenue must be recognized when earned, measurable, and realizable, regardless of the timing of the related cash flow. 8. Time-period assumption Accruals and deferrals arise because short-term (i,. E. , annual) financial statements must be prepared. Revenues and expenses must often be recognized at times other than when cash is received, 9. Revenue and matching; faithfulness; Freedom from bias Measurement should be free of bias.
Revenues are recognized when earned measurable and realizable. Expenses must be matched with revenue to obtain n earnings measure that is a faithful representation of the operating results of the company. Assignment 2-11 Initial transaction recognized Element realized by cash On sale On payment 1 August 12 September Cash receipt recognized and unearned revenue recognized 20 February Revenue recognized-? 10 March 1 July I July Daily End of six months 1 February I March Assignment 2-12 1.
Account payable (and utilities expense) 2 Patent, intangible asset; recorded at cost to create and register, usually a fraction of real worth due to reliability (measurement) problems in determining fair value at registration. 3. Not recognized; value to the company cannot be reliably measured, 4 Not recorded; not a financial statement element, If a contract existed with a future shareholder, the account receivable and subscribed common shares could be recognized. 5. Recognized, cost of work completed so tar (as inventory). 6. Not recognized; the amount to loss (it any) usually cannot be estimated accurately. . Not recorded; not reliably measurable past cost or torture benefit, and not the result of a transaction 8. Liability, an account payable (and utilities expense) on the SF-p; utility expense on the income statement. Assignment 2-13 I. E (or G if peripheral) 3. D (or if peripheral) Assignment 2-14 WEB O, F (and K) . E, O (and J) ICC. CGI Assignment 2-1 S WEB Case A: Comparability is violated. The accounting information is not comparable because the depreciation method is not consistent between periods. Case B: Representational faithfulness is not achieved.
The note receivable is not worth its face value at the time Of sale; it is over-valued. The note (and the sale transaction) must be shown at the notes present value of ASS,455: ($55,000 D 1. 21 – $45,455). However, if a time period to maturity is short, interest implicit often is ignored s immaterial. Case C: This situation violates relevance, including timeliness, even fifth information may be more representational taillight. The statements are out of date. Case D: Revenue recognition is inappropriate. Accrual accounting is usually appropriate, Case E: The revenue recognition principle is violated.
The time period during which the interest is earned is not properly accounted for. Accrual accounting must be followed. Case F: The separate-entity assumption is violated. Case G: Full disclosure is violated. Assignment 2-16 1. No revenue recognition (collection of accounts receivable). Revenue was already recognized, on delivery. 2. No revenue recognition (unearned revenue is created), 3. Revenue recognition-?one-twelfth of the subscription price received. 4. No revenue recognition-?there must be a sale transaction to recognize the increase in value. . Revenue recognition oft months’ interest, to reflect the passage of time, 6, Revenue recognition on delivery-?a slow-paying customer is still a valid customer; if payment was not probable, the sale would not be made. (If collection is considered to be especially problematic, installment sales or cost recovery might be applicable. Assignment 2-17 I _ The commitment is an executors contract. There will be no elements recognized until the inventory has been delivered or payment (full or partial) has been made, Whichever happens first. 2.
NO financial statement element has been created. The potential value of uninsured stock is not an asset. 3. Rent revenue and rent receivable are recognized because the services were rendered, measurable (assuming there is a lease that sets the price), and collection is probable. 4. The cost Of the trademark is recognized as an intangible asset, to be amortized as an expense over the five years. . Changes in value of foreign currency are recognized on the income statement as a gain (or loss) and on the balance sheet as an increase (or decrease) in an asset (cash). . Training costs should have a future value, but the future benefit cannot be measured, Therefore, training costs are recognized as an expense in the financial statements. There is no reliable measure of the value of the “asset”. 7. Competitor status is not recognized in the financial statements. There is no basis for recognition because no identifiable revenue has yet been received. 8. Future sots of site restoration are estimated and recognized as an asset and a liability, The asset is amortized over time, creating an expense.
Assignment 2-19 a) This entry violated the cost principle (and representational faithfulness) because the merchandise cost $78,400. The entries should have been: Inventory 78,400 Accounts payable ($80,000 x . 98) Accounts payable 78,400 Cash 78,400 b) The recording and reporting violated the matching principle and representational faithfulness. Depreciation meets the definition of an expense. Depreciation expense should be matched with the revenues of the period and ported on the income statement as an expense.
The correct entry is: Depreciation expense 227,000 Accumulated depreciation 227,000 The debit item is reported on the income statement. C) This entry violated the cost and matching principles as well as representational faithfulness Repairs do not meet the definition of an asset. Usual and ordinary repairs constitute a current expense, not an increase to the value of capital assets. However, no correction is needed because the amount is not material. D) This reporting Of the storm loss was in violation Of the matching principle, and presentational faithfulness.