Unit
1
The Rules
Rules of The Accounting "Game”
 The process of Accounting and bookkeeping are guided by
rules of process.
Why Have Rules ?
 All games such as football,
baseball, basketball, etc.
have rules.
 Why ?
 So that everyone plays the game the same way.
 Playing the Accounting "Game" is no different. .
 What if owners and managers could prepare
their business's financial statements the way
they felt like ?
 If a business was wanting a loan or credit,
they would have a tendency to overstate
the value of their assets and the value of
their business.
 If it came to taxes (we don't like to have to pay them),
let's expense and write off everything.
 As for measuring performance (profitability)
and comparing businesses in the same industry,
you'd have no idea as to who was actually doing
well and who wasn't. You couldn't even
compare your own business from year to year.
 So, to put all businesses on the same
playing field, the accounting profession
has established some rules and guidelines
 The current accounting rules and
standards are continually reviewed,
studied, changed, and added to in order
to make financial presentations more
consistent, comparable, meaningful,
and informative.
The Rules

Generally accepted accounting principles are a set of rules
and practices that are recognized as a general guide for
financial reporting purposes.

Generally accepted means that these principles must have
substantial authoritative support.

The Canadian Institute of Chartered Accountants (CICA)
is responsible for developing accounting principles in
Canada.
CICA’S CONCEPTUAL
FRAMEWORK

The conceptual framework consists of:
 objective of financial reporting,
 qualitative characteristics of
accounting information,
 elements of financial statements, and
 recognition and measurement criteria
(assumptions, principles, and
constraints).
OBJECTIVE OF FINANCIAL
REPORTING

The objective of financial reporting is to
provide information that is useful for
decision-making
QUALITATIVE CHARACTERISTICS
OF ACCOUNTING INFORMATION

The accounting alternative selected should be one that
generates the most useful financial information for
decision making.
 To
be useful, information should possess the
following qualitative characteristics:
1. understandability
2. relevance
3. reliability
4. comparability and consistency
UNDERSTANDABILITY

Information must be understandable by its
users.
 Users
are assumed to have a
reasonable comprehension of, and
ability to study, the accounting,
business, and economic concepts
needed to understand the information.
RELEVANCE

Accounting information is relevant if it makes
a difference in a decision.

Relevant information helps users forecast
future events (predictive value), or it confirms
or corrects prior expectations (feedback value).

Information must be available
to
decision makers before it
loses its
capacity to influence their decisions
(timeliness).
RELIABILITY



Reliability of information means that the
information is free of error and bias – it can be
depended on.
To be reliable, accounting information must be
verifiable – there must be proof that it is free of
error and bias.
The information must be a faithful representation of
what it purports to be – it must be factual.
COMPARABILITY AND
CONSISTENCY


Comparability means that the information should
be comparable with accounting information about
other enterprises.
Consistency means that the same accounting
principles and methods should be used from year
to year within a company.
2000
2001
2003
RECOGNITION AND
MEASUREMENT CRITERIA

Recognition and measurement criteria used by accountants to solve
practical problems include assumptions, principles, and constraints.

Assumptions provide a foundation for the accounting process.

Principles indicate how economic events should be reported in the
accounting process.

Constraints permit a company to modify generally accepted
accounting principles without reducing the usefulness of the reported
information.
Assumptions
Going concern
Monetary unit
Economic entity
Time period
Principles
Revenue recognition
Matching
Full disclosure
Cost
Constraint
s
Cost - benefit
Materiality
GOING CONCERN
ASSUMPTION
The going concern assumption assumes that the
enterprise will continue to operate in the foreseeable
future.
Implications: capital assets are recorded at cost
instead of liquidation value, amortization is used,
items are labeled as current or non-current.
MONETARY UNIT
ASSUMPTION


The monetary unit assumption states that only
transaction data capable of being expressed in terms
of money should be included in the accounting
records of the economic entity.
Also assumes unit of measure ($) remains
sufficiently stable over time. Ignores inflationary and
deflationary effects.
Should not be
included in
accounting records
Should be included
in accounting records
Customer satisfaction
Percentage of
international employees
Salaries paid
ECONOMIC ENTITY
ASSUMPTION
The economic entity assumption states that
economic events can be identified with a
particular unit of accountability.
Example: Harvey’s activities can be
distinguished from those of other food services
such as Swiss Chalet.
TIME PERIOD ASSUMPTION
The time period assumption states that
the economic life of a business can be
divided into artificial time periods.
Example: months, quarters, and years
2000
QTR 1
QTR 2
QTR 3
QTR 4
2001
JAN
MAY
SEPT
DEC
2003
FEB
MAR APR
JUN JUL
AUG
OCT
NOV
REVENUE RECOGNITION PRINCIPLE

The revenue recognition principle says that
revenue should be recognized in the accounting
period in which it is earned.
Revenue can be recognized:
1.
2.
3.
4.
At point of sale
During production
At completion of production
Upon collection of cash
MATCHING PRINCIPLE

Expense recognition is traditionally tied to
revenue recognition.

This practice – referred to as the matching
principle – dictates that expenses be matched
with revenues in the period in which efforts are
expended to generate revenues.
FULL DISCLOSURE PRINCIPLE

The full disclosure principle requires that
circumstances and events that make a difference to
financial statement users be disclosed.

A summary of significant accounting policies is
usually the first note to the financial statements.
COST PRINCIPLE


The cost principle dictates that assets are recorded
at their historic cost.
Cost is used because it is both relevant and
reliable.
1. Cost is relevant because it represents the
price paid, the assets sacrificed, or the
commitment made at the date of acquisition.
2. Cost is reliable because it is objectively
measurable, factual, and verifiable.
CONSTRAINTS IN ACCOUNTING
 Constraints
permit a company to modify
generally accepted accounting principles without
reducing the usefulness of the reported
information.

The constraints are cost-benefit and materiality.
1. Cost-benefit means that the value of
information should be greater than
the cost of providing it.
2. Materiality relates to an item’s impact
on a firm’s overall financial condition
and operations.