Kế toán, kiểm toán - Chapter 3: The measurement fundamentals of financial accounting

12Chapter 3:The Measurement Fundamentals of Financial Accounting3Identify and describe the four basic assumptions of financial accounting.Learning Objective 14Basic Assumptions of Financial AccountingBasic assumptions are foundations of financial accounting measurements The basic assumptions are:Economic entityFiscal periodGoing concernStable dollar5Economic EntityA company is assumed to be a separate economic entity that can be identified and measured.This concept helps determine the scope of financial statements.Examples — Disney and ABC, Comcast and NBC are presented as consolidated entities because of the ownership structure6Fiscal PeriodIt is assumed that the life of an economic entity can be broken down into accounting periods.The result is a trade-off between objectivity and timeliness.Alternative accounting periods include the calendar or fiscal year.7Going ConcernThe life of an economic entity is assumed to be indefinite.Assets, defined as having future economic benefit, require this assumption.Allocation of costs to future periods is supported by the going concern assumption.8Stable DollarThe value of the monetary unit used to measure an economic entity’s performance and position is assumed stable.If true, the monetary unit must maintain constant purchasing power.Inflation, however, changes the monetary unit’s purchasing power.If inflation is material, the stable dollar assumption is invalid.9Concept Practice 1 10Concept Practice 1 – cont. 11Distinguish the markets in which companies operate and the valuation bases used on the balance sheet.Learning Objective 212Valuations on the Balance SheetThere are a number of ways to value assets and liabilities on the balance sheet:Input market: cost to purchase materials, labor, overheadOutput market: value received from sales of services or inventoriesAlternative valuation basesPresent valueFair market valueReplacement costOriginal (historical) cost13Present Value as a Valuation BaseDiscounted future cash inflows and outflowsFor example, the present value of a notes receivable is calculated by determining the amount and timing of its future cash inflows and adjusting the dollar amounts for the time value of money.14Fair Market Value as a Valuation BaseFair market value is measured by the sales price or the value of goods and services in the output market.For example, short-term investments are adjusted to their fair market value, or sales price, at the end of the reporting period. 15Replacement Cost as a Valuation BaseReplacement cost is the current cost or the current price paid in the input market.For example, inventories are valued at original cost or replacement cost, whichever is lower.16Original (Historical) Cost as a Valuation BaseOriginal cost is the input price paid when asset originally purchased.For example, land and property used in a company’s operations are all valued at original cost.Under IFRS, certain companies are allowed to value property, plant, and equipment at fair market value.“Cash equivalent price” is used to calculate historical cost when cash is not paid (as in the issue of a liability to purchase the asset)17Valuation BasesUsed on the Balance Sheet - assets18Valuation BasesUsed on the Balance Sheet – liabilities & equity19Concept Practice 2 20Define the principle of objectivity and describe how it determines the dollar values that appear on the financial statements. Learning Objective 321Principles of Financial Accounting MeasurementWhen transactions occur, we must decide when to recognize the transactions in the financial statements, and how to measure the transactions.The principles of recognition and measurement are: ObjectivityMatchingRevenue recognitionConsistency22The Principle of ObjectivityThis principle requires that the values of transactions and the assets and liabilities created by them be verifiable and backed by documentation.For example, present value is only used when future cash flows can be reasonably determined.23Present Value and the Financial StatementsBased on the principle of objectivity, present value is only used when the future cash flows associated with assets and liabilities are predictable enough to allow for sufficient objectivity (like a legal contract).24Market Value and the Financial StatementsMarket values are attractive to use for objective values because they provide the best estimate of present value. However, not all items are actively traded and, therefore, may not have an objective market value25Original Cost and the Financial StatementsPrepaid expenses, land securities, property, plant, and equipment and intangible assets are valued at the cost originally acquired or net book value. These values can be objectively verified and are documented. 26Which one of the following statements best describes objectivity?a. When uncertainty exists, understating assets, overstating liabilities, accelerating recognition of losses, and delaying recognition of gains is preferred.b. The measurement of an event is verifiable and reliable.c. Different firms use identical accounting measurement methods for similar events.d. Objectives are laid out that are conservative or too aggressive by management.27Define and relate the principles of matching, revenue recognition, and consistency.Learning Objective 428The Principles of Matching and Revenue RecognitionEfforts of a given period should be matched against the benefits that result.Costs to generate revenues are matched against those revenues in that time period.Items that will help to generate revenues in the future will be expensed in the future.The most common point of revenue recognition is when the product or service has transferred to the buyer.29Revenue Recognition and Matching30Exercise 3-5Cascades Enterprises ordered 4,000 brackets from McKey and Company on December 1, 2017, for a contracted price of $40,000. Dec 1, 2017: Cascades orders bracketsJan 17, 2018: McKey completed manufacturingFeb 9, 2018: McKey delivered the bracketsMar 14, 2018: McKey received a check for $40,000a. Assume that McKey prepares monthly income statements. In which month should it recognize the $40,000 revenue from the sale? The most common point at which a company would recognize revenue is at the time of delivery/shipment. So in this case McKey and Company would recognize revenue in February.31b. Justify the answer in terms of the four revenue recognition criteria.The four criteria for recognizing revenue are (1) the company has completed a significant portion of the production and sales effort, (2) the amount of revenue can be objectively measured, (3) the title of goods has transferred to the buyer, and (4) cash collection is reasonably assured. 32c. Are there conditions under which the revenue could be recognized in a different month from the one chosen in (a)? Revenue could be recognized (1) during production, (2) at the completion of production, (3) at the point of delivery, or (4) when the cash is collected. Since the production and sales effort was not really complete until McKey shipped the brackets on February 9, February 9 appears to be the appropriate date to recognize the revenue. 33d. Why is the timing of revenue recognition important to McKey’s management?McKey's managers could be interested in the timing of revenue recognition due to incentives provided by contracts. For example, the managers may be paid a bonus based upon accounting income. Revenue recognition must portray a fair representation of the company’s financial activities to external users of the statements.3435The Principle of ConsistencyGenerally accepted accounting principles allow a number of different, acceptable methods of accounting.This principle states that companies should choose a set of methods and use them from one period to the next.For example, a change in the method of accounting for inventory would violate the consistency principle.However, certain changes are permitted with sufficient disclosure regarding the change.36Which one of the following is violated when a company recognized revenue upon the receipt of cash from a customer who has paid in advance for services?a. Expense policyb. Objectivityc. Matchingd. Revenue recognition criteria37List and explain the two major exceptions to the principles of financial accounting: materiality and conservatism.Learning Objective 538Exceptions (Constraints) to the Basic PrinciplesThese exceptions contradict the basic principles, in certain circumstances. They are:Materiality Conservatism 39MaterialityMaterialityOnly transactions with amounts large enough to make a difference are considered material (a reasonable investor would think it is important). Nonmaterial transactions can be given alternative treatmentsFor example, a trash can might have a five year life, but the materiality constraint allows a company to expense the item in the year purchased.40ConservatismThe conservatism constraint permits the choice of the more conservative alternative in certain situations where two alternatives exist regarding the valuation of a transaction.Conservatism - When in doubt:Understate assetsOverstate liabilitiesAccelerate recognition of lossesDelay recognition of gainsFor example, “lower of cost or market” is used to value inventory.Problem: Some managers have abused the conservatism constraint in earnings management.41Expensing the cost of a pencil holder that cost $1.25 instead of capitalizing it as a plant asset and depreciating it over its estimated useful life of 10 years:a. violates the economic entity assumption.b. violates GAAP since pencil holders are important assets. c. is justified because of materiality. d. is appropriate because of the stable dollar assumption. 42Which one of the following statements best describes the concept of conservatism? a. Profits should be accelerated in all cases.b. The measurement of an event is verifiable and reliable.c. The value of goods and services provided is recognized when earned.d. When uncertainty exists, understating assets, overstating liabilities, accelerating recognition of losses, and delaying recognition of gains is preferred.43Summarize the fundamental differences between U.S. GAAP and IFRS.Learning Objective 644Fundamental Differences – U.S. GAAP and IFRSIFRS is “principles-based” while U.S. GAAP is “rules-based”IFRS leaves more discretion to managementU.S. GAAP generally does not allow the use of fair market values unless they can be objectively determined. IFRS allows adjustments to the balance sheet values for changes in market value.45International PerspectiveDiscretion given to management under IFRS demands management depict performance in a “true and fair” manner.Still some believe that the additional discretion available to management under IFRS can be used to manipulate reported earnings. 46Wiley © 2017