Accounting Concepts, Assumptions and
Principles
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)
