intermediate/financial accounting: recognition & measurement concepts

WELCOME TO OUR PRESENTATION

Presenting ByPresenting By

1) MD.Wahidul Haque 111-11-19062)Baban Acharjee 111-11-18803)Farjana Faiza 111-11-19004)Abdullah ar rafsan 111-11-18925)Mahbub Alam 111-11-19036)Atikur Rahman 111-11-1891

Financial Accounting:

Recognition and measurement concepts

ASSUMPTIONSASSUMPTIONS

1.1. Economic entityEconomic entity

2.2. Going concernGoing concern

3.3. Monetary unitMonetary unit

4.4. PeriodicityPeriodicity

PRINCIPLESPRINCIPLES

1.1. MeasurementMeasurement

2.2. Revenue recognitionRevenue recognition

3.3. Expense recognitionExpense recognition

4.4. Full disclosureFull disclosure

CONSTRAINTSCONSTRAINTS

1.1. Cost-benefitCost-benefit

2.2. MaterialityMateriality

3.3. Industry practiceIndustry practice

4.4. ConservatismConservatism

OBJECTIVESOBJECTIVES1. 1. Useful in investment Useful in investment

and credit decisionsand credit decisions2. 2. Useful in assessing Useful in assessing

future cash flowsfuture cash flows3. About enterprise 3. About enterprise

resources, claims to resources, claims to resources, and resources, and changes in themchanges in them

ELEMENTSELEMENTS

Assets, Liabilities, and EquityAssets, Liabilities, and EquityInvestments by ownersInvestments by ownersDistribution to ownersDistribution to ownersComprehensive incomeComprehensive incomeRevenues and ExpensesRevenues and ExpensesGains and LossesGains and Losses

Illustration 2-7 Conceptual Framework for Financial Reporting

First level

Second level

Third level

QUALITATIVE QUALITATIVE CHARACTERISTICSCHARACTERISTICS

RelevanceRelevance

ReliabilityReliability

ComparabilityComparability

ConsistencyConsistency

Recognition and measurement concepts

ASSUMPTIONS

PRINCIPLES

CONSTRAINTS

Assumptions

1)Economic entity

2)Going concern

3)Monetary Unit

4)Periodicity

Principals

1)Historical cost

2)Revenue recognition

3)Matching

4)Full disclosure

Constraints

1) Cost-benefit

2)Materiality

3)Industry practice

4) Conservatism

Basic Assumptions

Economic Entity AssumptionEconomic Entity Assumption Economic Entity AssumptionEconomic Entity Assumption

The economic entity can be identified with a particular unit of accountability

The activity of a business enterprise is separate and distinct from its owners

Entity’s assets and other financial elements are separate from the owner’s

The economic entity assumption is an accounting concept and not a legal construct

EXAMPLE

BMW activities

can be distinguished from those of other carmanufacturers such as Mercedes.

Going Concern AssumptionGoing Concern Assumption Going Concern AssumptionGoing Concern Assumption

The business enterprising will have a long life

The business is assumed to continue indefinitely unless terminated by owners

The basis of recoding financial elements is historical cost accounting

Liquidation accounting (based on net realizable value) is not followed unless so indicated

EXAMPLEEXAMPLEEXAMPLEEXAMPLE

The going concern assumption assumes that the enterprise will continue to operate in the foreseeable future.

Monetary Unit AssumptionMonetary Unit AssumptionMonetary Unit AssumptionMonetary Unit Assumption

Money is the common unit of measure of economic transactions

The use of monetary unit is relevant, simple, universally available, understandable and useful

Price level changes (inflation and deflation) are ignored in accounting, leading to the assumption that the dollar remains relatively stable

Customer satisfaction

Percentage of international employees

Salaries paid

Customer satisfaction

Percentage of international employees

Salaries paidShould be includedin accounting records

Should be includedin accounting records

Should not be included in accounting records

EXAMPLE

Periodicity (Time Period) AssumptionPeriodicity (Time Period) Assumption Periodicity (Time Period) AssumptionPeriodicity (Time Period) Assumption

Economic activities of an entity can be divided into artificial time periods (monthly, quarterly, yearly) for reporting purposes

The shorter the time period, the more difficult it becomes to determine the proper net income for the period

Investors usually demand that accounting information be quickly processed but the faster it is released, the more it is subject to error

EXAMPLE

The time period assumption states that the economic life of a business can be divided into artificial time periods.

Example: months, quarters, and years

QTR 1QTR 2QTR 3QTR 4

2000 2001 2003

JAN FEB MAR APR MAY JUN JUL AUG SEPT OCT NOV DEC

Basic Principles

BASIC PRINCIPLES USED IN ACCOUNTING

Historical Cost PrincipleHistorical Cost PrincipleHistorical Cost PrincipleHistorical Cost Principle

Most assets and liabilities are recorded at its acquisition price

Cost has an important advantage over other valuations : it is reliable

Historical cost provides a reliable benchmark for measuring historical trends.

Fair value information may be more useful.

The current system is a“mixed attribute” incorporating historical cost, fair value, lower of cost or market, and other valuation bases

Revenue Recognition PrincipleRevenue Recognition PrincipleRevenue Recognition PrincipleRevenue Recognition Principle

Revenue is recognized when it is realized or realizable, and earned

Revenue is realized when goods or services are exchanged for cash or claims to cash

Revenue is realizable when assets received or held are readily convertible into cash or claims to cash

Revenue is earned when the entity has substantially accomplished what it must do to be entitled to the benefits represented by the revenues

Revenue Recognition PrincipleRevenue Recognition Principle Revenue Recognition PrincipleRevenue Recognition Principle

Usually, revenue is recognized at the time of sale

However, there are exceptions :

1. During Production : In long-term construction contracts, revenue is recognized periodically based on the percentage of job completed

2. End of Production (After production but before sales) : Where active markets exist for the product and there are no significant additional cost

3. Receipt of cash : Used when it is impossible to establish the revenue amount at the time of sale because of the uncertainty of collection. E.g. In installment sales methods, payment is required in periodic installments –> risk of uncollectible

EXCEPTIONSEXCEPTIONS

Timing of revenue recognition

Matching PrincipleMatching Principle Matching PrincipleMatching Principle

Efforts (expenses) are to be matched with accomplishment (revenues)

Expenses are matched to the revenues they help to generate

Costs that are related to the revenue are expensed and matched against the revenue in the period the revenue is recognized

When there is no connections between costs and revenues, an allocation of cost based on some systematic basis might be appropriate, e.g. The cost of fixed assets is allocated throughout its useful life because the asset contributes to the generation of revenue

Matching PrincipleMatching Principle Matching PrincipleMatching Principle

If the allocation method is not desirable, then the cost is expensed off immediately

Costs are generally classified into two groups :-

1. Product Costs : Material, labour and overhead attach to the product and carried into future periods if the revenue from the product is recognized in subsequent periods

2. Period Costs : Officers’ salaries and other administrative expenses are charged off immediately even though benefits associated with these costs occur in the future, because there is no direct relationship between cost and revenue

Expense Recognition

Full Disclosure PrincipleFull Disclosure Principle Full Disclosure PrincipleFull Disclosure Principle

Providing information that is of sufficient importance to influence the judgment and decisions of an informed user

Disclosure can be made : Within the main body of financial statements

- The item should meet the definition of a basic element, be measurable with sufficient certainty and be relevant and reliable

In the notes to financial statements - Generally explain the items presented in the main

body of the financial statements

As supplementary information - May include information that is high in relevance but

low in reliability, or that is helpful but not essential

Full Disclosure – Provided through financial statements, notes to the financial statements, and supplementary information.

ExampleExample

Constraints

CONSTRAINTS IN ACCOUNTING

Cost-Benefit RelationshipCost-Benefit Relationship Cost-Benefit RelationshipCost-Benefit Relationship

The cost of providing information should not outweigh the benefit derived from the information

However, costs and especially benefits are not always obvious or measurable

Sound judgment must be used in providing information

MaterialityMateriality MaterialityMateriality

Materiality refers to an item’s significance to a firm’s overall financial operations

An item must make a difference to be material and to be disclosed

It is also a matter of relative significance of the element

E.g. If the amount involved is significant compared with other revenues and expenses, assets and liabilities, or net income of the entity, then sound and acceptable standards should be allowed

Industry PracticesIndustry PracticesIndustry PracticesIndustry Practices

An entity may follow the general practices in the firm’s industry, which sometimes requires departure from basic accounting theory

If application of accounting theory results in statements that are not comparable or consistent, then industry practices must be examined for possible explanations

ConservatismConservatism ConservatismConservatism

Conservatism suggests that when in doubt, the preparer should always choose a conservative solution

This solution will be least likely to overstate assets and income

However, bear in mind that conservatism does not suggest that net assets or net income to be deliberately understated

ANY QUESTIONANY QUESTION

???

The EndThe End