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									CGA - FA1 - Financial Accounting 1




       Welcome to the CGA on-line course -- FA1: Financial Accounting 1

       The content you will view in this online product is intended to enhance your understanding of the key
       topical areas of most difficulty to students throughout the course. This product is not intended to
       replace your current CGA-Canada education material but it will allow you to test your knowledge of the
       subject matter.

       The content providers for this course are:

       Helen Farkas, BAccS, CGA lectures for CGA Ontario and McMaster University's Centre for Continuing
       Education. She is the accountant for the Hamilton Branch of the Canadian Mental Health Association
       and manages her own public practice.

       Jennifer Harper, CGA has a BA in Applied Arts and a CGA designation. Jennifer is employed by the
       Canada Customs and Revenue Agency as a Team Leader.

       To improve these products and develop new ones, we need your feedback! Please send it to Carol
       Tristani, MBA, CGA, CGA Ontario's manager of student services at ctristani@cga-ontario.org.




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Unit 1: Foundation Review > Contents


        Contents

        Objectives           | page | 1 |

        Introduction            | page | 1 |

        Accounting             | page | 1 | 2 | 3 | 4 | 5 | 6 |

        Financial Statements                  | page | 1 | 2 | 3 | 4 | 5 | 6 | 7 |

        GAAP          | page | 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | 9 | 10 | 11 | 12 |

        Ethics        | page | 1 | 2 |

        Test       | page | 1 |

        This unit contains 30 pages in total.




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Unit 1: Foundation Review > Objectives


        Objectives

        Upon completion of this unit you should be able to:

               q   Define accounting and describe how accounting information helps internal and external users
                   to make decisions
               q   Describe the financial statements that are used to present financial information to users
               q   Understand the principles of GAAP and the conceptual framework of accounting
               q   Describe the ethical considerations faced by accountants in applying the conceptual framework
                   in practice




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Unit 1: Foundation Review > Introduction


        Introduction

        In this unit we will look at the definition of accounting and its relationship to providing information for
        decision making by internal and external users.

        We will look at how the information is presented in general purpose financial statements through a brief
        overview of the income statement, the balance sheet, the statement of changes in owner's equity, the
        statement of retained earnings, the statement of comprehensive income, and the cash flow statement.

        We will review the conceptual framework of accounting, including gaining an understanding of
        generally accepted accounting principles (GAAP) as outlined in Section 1000 of the CICA Handbook.

        In our final topic we will discuss the ethical considerations for accountants in applying the conceptual
        framework.




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Unit 1: Foundation Review > Accounting


        Accounting

        Objectives
        Accounting is a service activity that provides quantitative and qualitative financial information about
        economic entities. It requires that economic events be identified and analyzed in order to interpret,
        measure, record, summarize and report the information arising from the economic events for use by
        both internal and external users.

        The objective of accounting is to provide information that meets the needs of users, primarily to aid
        them in making resource allocation decisions and assessing stewardship. The statements we will be
        studying in this and other financial accounting courses in the CGA program are general purpose
        statements that will usually meet the needs of most external financial statement users.

        External users include:

               q   Creditors
               q   Investors
               q   Government
               q   General public




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Unit 1: Foundation Review > Accounting


        Accounting

        Objectives (continued)
        Financial information, including the general purpose statements, is also required by internal users for
        decision making.

        Internal users include:

               q   Owners actively involved in the business
               q   Management

        Answer the following true or false question to test your understanding of external and internal users of
        Financial Statements.

        Shareholders would always be considered external users of Financial Statements.


                True


                False



        Answer

        False. Shareholders would be considered external users of financial statements if they are not actively
        involved in the day to day operations of the organization. However many companies are "closely held",
        meaning that all, or most of, the shares are held by the person or persons who also operate the
        business, in which case they would be internal users.




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Unit 1: Foundation Review > Accounting


        Accounting

        Objectives (continued)
        Financial statements are an end product of the accounting function. As such, they are the means by
        which information is provided for external reporting and internal management.

        Let's take a look at how financial statements can help external users make decisions:

        For creditors, the information can help them decide:

               q   If the company has sufficient short term assets to meet current liabilities
               q   If the company has paid its debts promptly
               q   If, given the level of current debt, additional credit should be extended

        For investors, the information can help them determine:

               q   If management has made efficient use of company resources
               q   If the company is still a good investment, or should they sell their shares

        For government, the information can help them determine:

               q   If the company is meeting all regulatory requirements
               q   How much income tax the company owes




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Unit 1: Foundation Review > Accounting


        Accounting

        Objectives (continued)
        Internal users of financial statements (owners and managers) use information to:

               q   Determine efficiency of operations such as:
                       r How quickly are they collecting their receivables?

                       r Are levels of expenses appropriate for the related revenue generated?

                       r Are assets being used efficiently?

               q   Determine management bonuses

        Let's try a quiz to test our understanding so far.

        Quiz:

              1. Financial statements help external users make decisions by providing them with financial
                 information. Which of the following is not a decision that would be made by an external user?
                 A. Deciding if the company has complied with all regulatory requirements.
                 B. Deciding if a pending lawsuit that has been disclosed in the notes to the financial
                 statements will adversely impact share price.
                 C. Deciding if a company should extend further credit to one of their customers.
                 D. Deciding if the company has paid all its debts in a timely manner to avoid excessive
                 interest charges.
              2. Which of the following is not an external user of financial information?
                 A. Government agencies
                 B. Investors
                 C. Managers
                 D. Employees
              3. Characteristics of accounting considered essential include:
                 A. Identification and measurement of the economic events of an entity
                 B. Identification, measurement, and reporting of financial information about an economic entity
                 to interested users
                 C. Identification, measurement, and reporting of financial information about an economic entity
                 to management
                 D. Identification and reporting of financial information about an economic entity to internal and
                 external users
              4. The primary objective of financial reporting is to:
                 A. Provide audited financial information
                 B. Report information useful in assessing stewardship and making resource allocation decisions
                 C. Determine how much managers should receive in bonuses
                 D. Calculate how much is owed by the company for income taxes
              5. Preparers of financial information should consider user needs:
                 A. Because users want the same financial information preparers want to prepare
                 B. Only when they know who will be using the financial information
                 C. Because the objective of preparing financial statements is to provide information that will
                 meet user needs
                 D. Only when users have paid for the information

        Correct Answer:

              1. C
                 Reason: This is a decision that would be made by management, not an external user.
              2. C


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                Reason: Managers are internal users, not external users, of the financial information of an
                organization.
             3. B
             4. B
             5. C




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Unit 1: Foundation Review > Accounting


        Accounting                                                                                                    Audit -- an independent
                                                                                                                      review and test of an
        Fields of Accounting                                                                                          organization's accounting
        There are four broad areas of accounting:                                                                     systems and records.
                                                                                                                      External audits are
               q   Financial accounting -- involves the preparation of general purpose financial statements to be     required in many
                   provided to decision makers not involved in day-to-day operations of an organization. The          instances such as for
                   information provided by these statements are often presented only after they have undergone        companies whose shares
                   an audit.                                                                                          are traded on the stock
               q   Managerial accounting -- also involves preparing general purpose financial statements but in       exchange. Internal audits
                   addition collects and reports a great deal of additional information on costing, budgeting,        are performed by audit
                   internal controls and internal efficiencies. This information is provided to managers and owners   committees within an
                   directly involved in operations of the organization.                                               organization to determine
               q   Tax accounting -- involves preparation of tax returns, tax planning, assessing tax compliance,     efficiencies of
                   investigating violations, and writing regulations.                                                 management and
               q   Not-for-profit accounting -- involves preparation of financial information for not-for-profit      operations.
                   organizations such as hospitals, universities and charities.




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Unit 1: Foundation Review > Accounting


        Accounting

        Fields of Accounting (continued)
        Accountants are classified as:

               q   Industry accountants -- usually work for one employer and offer general accounting, cost
                   accounting, budgeting, and internal auditing
               q   Public accountants -- work for many clients and offer auditing, management advisory, and tax
                   services.
               q   Government accountants -- audit tax returns and accumulate information for federal, provincial,
                   and municipal agencies

        As we can see, accountants, regardless of the "type" they are classified as, may be involved in several
        different areas of accounting. For example, a public accountant may audit general purpose financial
        statements, provide management advisory services, and prepare tax returns for clients.

        Accountants work with a variety of legal forms of business organizations including:

               q   Sole proprietorships -- business owned by one individual, but not a separate entity under law
               q   Partnerships -- similar to sole proprietorships, but there is more than one owner. Sole
                   proprietors and partnerships are personally liable for the debts of the business
               q   Corporations -- Legally, it is a separate entity such that the owners (shareholders) are not liable
                   for the debts of the corporation.

        We will look at each of these business entities in more detail in subsequent units.

        Let's try the Pop Quiz to test our understanding to this point.

        Quiz (True and False):

              1. In general, employees would be considered external users of financial statements.
              2. Public accountants operate in the areas of financial accounting and tax accounting, but never in
                 management accounting.
              3. The main objective of accounting is to provide information that is useful for decision making.
              4. An audit is necessary if financial statements are prepared for external users.

        Correct Answers:

              1.   True.
              2.   False.
              3.   True.
              4.   False.




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Unit 1: Foundation Review > Financial Statements


        Financial Statements

        Types
        Accountants prepare the financial information required by users in the form of the following financial
        statements:

               q   Income statement
               q   Statement of owner's equity
               q   Statement of retained earnings
               q   Statement of comprehensive income
               q   Balance sheet
               q   Cash flow statement

        In subsequent units, we will look at each of these statements in more detail. For now, we will just look
        at each statement briefly to understand the type of information it provides for decision makers.




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Unit 1: Foundation Review > Financial Statements


        Financial Statements

        Income Statement
        We have determined that financial statement users want information that is useful for decision making.
        They will want to know how well a company did over a period of time.

        This information will be contained in the income statement which measures the results of operations
        over a specific time period and answers the question: "Did the business make a profit or a loss?"

        Net income (or loss) is measured by the following formula:

                                                 Net income (net loss) = Revenues - Expenses

        Revenues are the cash or other properties received by a business in return for goods or services
        provided by the business to their customers.

        Expenses are the goods and services consumed by the business in the course of earning revenue.
        They include such things as salaries, rent and utilities.

        To view a sample of this statement.




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Unit 1: Foundation Review > Financial Statements


       Financial Statements

       Statement of Owner's Equity
       This statement will provide information to the user on how much the owner has invested in the business as at the
       date specified on the statement of owner's equity as compared with the previous period.

       The amount shown here is a cumulative amount that shows how much the owner has invested in his business at
       the beginning of the period specified on the statement, less any withdrawals the owner has made from the business
       in the current period, plus the net income earned by the business in the current period (or less the net loss incurred
       by the business in the current period). Any additional contributions of capital would also be added.

       The formula for this statement would be:

           Opening owner's equity - withdrawals + Net Income (or - Net loss) + additional contributions = Closing owner's
                                                             equity

       To view a sample of this statement.




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Unit 1: Foundation Review > Financial Statements


       Financial Statements

       Statement of Retained Earnings
       This statement is similar in some ways to the statement of changes in owner's equity but is used for business
       entities that are corporations. Also, unlike the statement of owner's equity, the statement of retained earnings will
       not include any investments by owners. (For a corporation, the owners are the common shareholders). Retained
       earnings is calculated by the following formula:

             Opening Retained Earnings from the previous year + any net income (or - any net loss) of the current year -
                            dividends paid to shareholders in current year = Ending Retained Earnings.

       The ending retained earnings balance calculated here will be used in the shareholders' equity section of the
       balance sheet.

       To view a sample of this statement.




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Unit 1: Foundation Review > Financial Statements


        Financial Statements

        Statement of Comprehensive Income

        Note: For 2005/2006, this statement is not examinable. However, after October 1, 2006 reporting
        comprehensive income will be required for some organizations so it is briefly introduced in FA1.

        Comprehensive income includes all revenues, expenses, gains and losses included in net income as
        well as gains and losses not recognized in net income but affect shareholders' equity. It is calculated
        as:

                      Net income of the current year + other comprehensive income of the current year =
                                                   Comprehensive income.

        Other comprehensive income includes unrealized gains and losses on translation of financial
        statements of self-sustaining foreign operations, unrealized gains and losses on foreign currency
        hedges, and unrealized gains and losses on financial assets that are available for sale.

        Other comprehensive income calculated for a particular year will be added to the opening balance of
        accumulated other comprehensive income from other years and included in the shareholders' equity
        section of the balance sheet as accumulated other comprehensive income.

        To view a sample of this statment. Note that this statement can also be combined with the income
        statement and presented as one statement.




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Unit 1: Foundation Review > Financial Statements


        Financial Statements

        Balance Sheet
        This statement will provide information to the user on the financial position of the organization as at the
        date specified on the balance sheet.

        The balance sheet shows that:

                          Assets of the business = Liabilities of the business + Owner's equity in the business

        This is represented in the formula:

                                                                                 A = L + OE

        We look at this formula, known as the accounting equation, in more detail in the next unit.

        Assets are the resources owned by the business such as cash, accounts receivable, inventory, building
        and land.

        Liabilities are the debts owed by the business, such as accounts payable, loans to creditors, salaries owed,
        and taxes payable.

        From this we can see how the equity on the balance sheet is a residual amount by rearranging the
        accounting equation as follows:

                                                            Assets - Liabilities = Owner's equity

        We can also see why owner's equity is sometimes referred to as net assets.

        To view a sample of this statement.




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Unit 1: Foundation Review > Financial Statements


       Financial Statements

       Cash Flow Statement
       This statement shows the cash inflows and outflows from:

               q   Operating activities
               q   Investing activities
               q   Financing activities

       It gives users information on what the sources of cash were during the period and how cash was spent during the
       period.

       The amount of cash reported on the cash flow statement at the end of the accounting period will be the same as the
       cash amount appearing on the balance sheet.

       To view a sample of this statement.




       Let's test our understanding of the purpose of the different financial statements with a quiz.

       Quiz:

              1. The accounting equation: Assets = Liabilities + Owner's Equity is representative of which of the following
                 financial statements:
                 A. Income Statement
                 B. Balance Sheet
                 C. Cash Flow Statement
                 D. Statement of Owner's Equity
              2. The income statement represents a company's results of operations:
                 A. At a specific point in time


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                B. For a period of time
                C. At the end of the accounting period
                D. None of the above
             3. An income statement is useful because it answers the following question for users:
                A. What is the company's financial position at the date the income statement was prepared?
                B. How much has the owner contributed to the business this year?
                C. What were the company's results of operations for the year?
                D. How much has the owner withdrawn from the company during the year.
             4. Net assets is:
                A. The same as net income
                B. Equal to assets less liabilities
                C. Measured as assets less accumulated amortization
                D. None of the above
             5. Which of the following won't be found on a Statement of Retained Earnings?
                A. Net Income
                B. Net Loss
                C. Common Shares
                D. Dividends

      Correct Answer:

             1.   B
             2.   B
             3.   C
             4.   B
             5.   C




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Unit 1: Foundation Review > GAAP


        GAAP

        Defined
        We have identified that accounting has the broad purpose of providing financial information that will be
        useful to external and internal users for decision making.

        We have also identified the specific statements that will provide this information to users.

        What we need to consider now is how do we ensure that the information contained on the statements
        will be of sufficient quality to meet the users' needs.




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Unit 1: Foundation Review > GAAP


        GAAP

        Defined (continued)
        Generally accepted accounting principles (GAAP) are the rules adopted by the accounting profession
        as guidelines for measuring, recording, and reporting the financial transactions and activities of a
        business.

        GAAP is divided into primary sources and other sources. Primary sources of GAAP are listed in
        Handbook section 1100 as follows:

               q   Handbook sections 1300-4460, including Appendices and Board Notices
               q   Accounting Guidelines, including Appendices and Board Notices
               q   Background Information and Basis for Conclusions documents including appendices
               q   EIC abstracts
               q   Illustrative Examples of the pronouncements noted above
               q   Implementation Guides authorized by the Board

        Important to note that the above is a hierarchical list. For instance an interpretation of an Accounting
        Guideline could not be implemented if it would contradict a provision of one of the Handbook sections
        1300-4460.

        Other sources of GAAP that are included in Section 1100 are to be considered when primary sources
        do not deal with a specific issue. Nonetheless, the accounting policy adopted in consultation with other
        sources must be consistent with primary sources of GAAP and the conceptual framework of
        accounting as laid out in section 1100. These other sources include:

               q   Pronouncements by accounting standard-setting bodies in other jurisdictions
               q   Research studies
               q   Accounting text books, journals, studies, and articles.




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Unit 1: Foundation Review > GAAP


        GAAP

        Defined (continued)
        Section 1000 of the CICA Handbook provides us with the financial statement concepts we'll need to
        ensure that the information we prepare will be of sufficient quality and quantity to meet user needs.

        Only financial statements prepared in accordance with the provisions of this section will be considered
        prepared according to GAAP. When regulatory or legislative requirements conflict with this section,
        users must be informed that the statements are not prepared according to GAAP and the policies used
        must be disclosed. Therefore, if GAAP prepared statements are also required, two sets of statements
        will need to be prepared. Nonetheless, the Accounting Standards Board attempts to minimize the
        instances when confilicting requirements may exist.

        In the next topic we will look at the conceptual framework of accounting that:

               q   Specifies the objectives of financial statements (which we have already been exploring)
               q   Identifies qualitative characteristics of financial statements needed for decision usefulness
               q   Describes the elements of financial statements (some, such as revenue, expenses, assets,
                   liabilities, and owner's equity to which we have already been introduced)
               q   Outlines the recognition and measurement guidelines including the assumptions, principles,
                   and constraints related to recognizing and measuring financial information.

        Before we continue, let's try the following quiz.

        Quiz (True and False):

              1. In order to be useful, statements must be prepared in accordance with Generally Accepted
                 Accounting Principles (GAAP).
              2. Any alternative provided by GAAP will result in financial statements that are useful to decision
                 makers.
              3. Pronouncements by the International Accounting Standards Board (IASC) are considered a
                 primary source of GAAP..
              4. GAAP requires the use of professional judgement in its application.
              5. A pronouncement on an accounting issue by the U.S. Financial Accounting Standards Board
                 (FASB) will take precedence over a pronouncement of the International Accounting Standards
                 Board (IASB) on the same accounting issue.

        Correct Answers:

              1.   False.
              2.   False.
              3.   False.
              4.   True.
              5.   False.




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Unit 1: Foundation Review > GAAP


        GAAP

        Information Quality
        The following diagram depicts the conceptual framework of accounting. Click on each section for more
        information.




        Objectives of Accounting Information

        Accounting is a service activity that provides quantitative and qualitative financial information about
        economic entities. It requires that economic events be identified and analyzed in order to interpret,
        measure, record, summarize and report the information arising from the economic events for use by both
        internal and external users. The basic objective of accounting is to provide information that meets the
        needs of users.


        Qualitative Characteristics of Financial Statements




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       Relevance and reliability are considered the primary qualities that must be present.

       Relevance is achieved if its existence makes a difference in the decision making process. Relevant
       information will have:

              q   Predictive value (helps user in forecasting outcomes of past or present events)
              q   Feedback value (has ability to confirm or correct prior expectations relating to past decisions and
                  events)
              q   Timeliness (information is available in time to influence users' decisions)

       Reliability is achieved if the information is free from error and bias to reduce the risk to the users who
       base decisions on it. Reliable information will have:

              q   Representational faithfulness (amounts reported on the financial statements are faithful
                  representations of the economic resources of an organization, the claims to these resources, and
                  the residual equity of the enterprise)
              q   Verifiability (consensus by others on the measurement methods used for the financial information
                  ends with the same quantitative result)
              q   Neutrality (freedom from bias or attempts by preparers to influence decisions)
              q   Conservatism (when more than one valid alternative exists, the least optimistic is chosen if risk or
                  uncertainty exists)

       Understandability is achieved if the user can perceive the significance of the information (assuming that
       the user has a reasonable understanding of accounting information)

       Comparability is achieved in two ways:

              q   If the user is able to make comparisons between entities, particularly companies in the same
                  industry
              q   If the user is able to compare the results of one entity from one year to the next

       Note the importance of consistency to comparability -- comparison can only be achieved if accounting
       policies are applied consistently from year to year (or entity to entity, though this is difficult, given there is
       often no requirement that businesses in the same industry use the same accounting policies.)


       Elements of Financial Statements

       Assets are the resources owned by the business such as cash, accounts receivable, inventory, building
       and land.

       Liabilities are the debts owed by the business, such as accounts payable, loans to creditors, salaries
       owed, and taxes payable.

       Equity is a residual amount, measured by the difference between Assets and Liabilities, hence it is
       sometimes referred to as Net Assets.

       Owner investments could include common stock purchases for a corporation and capital contributions for
       a sole proprietorship or partnership.

       Distribution to owners are represented on financial statements by means of dividends for a corporation
       and owner withdrawals for a sole proprietorship.

       Gains are increases in equity from peripheral or incidental transactions or events other than those that
       result from revenues or equity/net assets contributions.

       Losses are decreases in equity from peripheral or incidental transactions or events other than those that
       result from expenses or distributions of equity/net assets.

       Revenues are the cash or other properties received by a business in return for goods or services provided
       by the business to their customers.


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       Expenses are the goods and services consumed by the business in the course of earning revenue. They
       include such things as salaries, rent and utilities.


       Assumptions

       Separate Entity -- Every business is an entity, separate and distinct from its owner(s) and from every
       other business. Economic events of one entity should not be mixed with those of another entity when
       determining performance of the entity.

       Going Concern -- The business will continue to operate for an indefinite period and its assets, other than
       inventory, will not be sold but used to generate income. This justifies the reason for not revaluating capital
       assets as there is no intention to sell them. This does not hold true if an entity will not continue to operate,
       and thus market or liquidation values would be used to value all assets.

       Unit of Measure -- Assumes money, not some other asset such as beans or steel, is used to measure the
       results of operations and the financial position of a business. It also assumes a stable measuring unit,
       such that no adjustment is made for the monetary unit's purchasing power as a result of inflation or
       deflation.

       Time Period -- The life of a business is assumed to be indefinite, therefore periodic reports are needed for
       users to judge performance for a specific time frame. Otherwise these reports wouldn't be prepared until
       the business does finally end. These time frames are often set at one year intervals to report annual
       results, though the date at which the time period will start and end is often set arbitrarily. Interim reports,
       for example on a monthly basis, are also frequently prepared.


       Principles

       Cost principle -- based on unit of measure assumption of stable monetary unit, the cost used in valuation
       is historical cost (the cost on the date of acquisition). In cases where assets were obtained in a non cash
       transaction, fair values of the assets exchanged are considered. The cost principle is frequently overridden
       by relevancy issues such that assets may be reported at market values which may be more or less than
       their historical cost.

       Revenue recognition principle -- revenue is recognized when earned, not when received. Revenue is
       considered earned for goods when the risks of ownership have transferred to the buyer or for services
       when the service has been performed. Revenue will be recognized only if payment is assured.

       Matching principle -- Requires that expenses be recorded in the same period as the related revenue, not
       when incurred. When costs are incurred that relate to future benefits, these costs are not recognized as
       expenses until the time the benefit is recognized. Some costs, where future benefits are uncertain, such as
       advertising expenses, are recognized when incurred.

       Full-disclosure principle -- Because GAAP permits various alternatives, users must be made aware of
       which practices the business entity is using. Full disclosure is provided in the notes to the financial
       statements and enhances the reliability and relevance, and thus the usefulness, of the financial
       statements. The use of notes can also provide other helpful information not provided in the body of
       financial statements such as current market values of assets.


       Constraints




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       Cost-benefit -- Evaluating the cost of producing financial information to determine if the benefits derived
       from having the information will outweigh the costs of producing or obtaining it.

       Materiality -- if an amount is determined to be not large enough to influence a user of the information, a
       more expedient way of producing the information may be undertaken. Justification is that the relevance or
       reliability of the financial information would not be materially important to the user.




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Unit 1: Foundation Review > GAAP


        GAAP

        Information Quality (continued)
        As we have already discussed, we can see that the basic objective of preparing financial statements is
        to provide information useful for decision making.

        Information will be useful if it has the qualitative characteristics of:

               q   Understandability
               q   Relevance
               q   Reliability
               q   Comparability

        Understandability is achieved if the user can perceive the significance of the information (assuming
        that the user has a reasonable understanding of accounting information)

        Comparability is achieved in two ways:

              1. If the user is able to make comparisons between entities, particularly companies in the same
                 industry
              2. If the user is able to compare the results of the same entity from one year to the next

        Note the importance of consistency to comparability -- comparison can only be achieved if accounting
        policies are applied consistently from year to year (or entity to entity, though this is difficult, given there
        is often no requirement that businesses in the same industry use the same accounting policies.)

        Relevance and reliability are considered the primary qualities that must be present. Let's look at these
        two qualities in more detail




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Unit 1: Foundation Review > GAAP


        GAAP

        Information Quality (continued)
        Relevance is achieved if its existence makes a difference in the decision making process. Relevant
        information will have:

               q   Predictive value (helps user in forecasting outcomes of past or present events)
               q   Feedback value (has ability to confirm or correct prior expectations relating to past decisions
                   and events)
               q   Timeliness (information is available in time to influence users' decisions)

        Reliability is achieved if the information is free from error and bias to reduce the risk to the users who
        base decisions on it. Reliable information will have:

               q   Representational faithfulness (amounts reported on the financial statements are faithful
                   representations of the economic resources of an organization, the claims to these resources,
                   and the residual equity of the enterprise)
               q   Verifiability (consensus by others on the measurement methods used for the financial
                   information ends with the same quantitative result)
               q   Neutrality (freedom from bias or attempts by preparers to influence decisions)
               q   Conservatism (when more than one valid alternative exists, the least optimistic is chosen if risk
                   or uncertainty exists)

        Often it is not possible to have information that is both completely relevant and completely reliable at
        the same time -- in those instances, a trade-off between these two qualitative characteristics must be
        made, while keeping the statements as useful as possible.

        Let's test our understanding of the qualitative information required for useful financial reporting.

        Quiz:

              1. Under the CICA Handbook section dealing with financial statement concepts, timeliness is
                 essential to the primary quality called:
                 A. Verifiability
                 B. Relevance
                 C. Reliability
                 D. Comparability
              2. Neutrality is a component of:
                 A. Relevance
                 B. Reliability
                 C. Comparabi
                 D. Predictive valuelity
              3. Kenora Company continued to use the same amortization policy and inventory costing method
                 year after year. This is illustrated by the following concept of:
                 A. Predictive value
                 B. Comparability
                 C. Verifiability
                 D. Conservatism
              4. Predictive value is a component of:
                 A. Relevance
                 B. Comparability
                 C. Reliability
                 D. Timeliness


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       Correct Answers:

             1.   B
             2.   B
             3.   B
             4.   A




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Unit 1: Foundation Review > GAAP


        GAAP

        Financial Statement Elements
        When discussing the information provided to users by way of the financial statements we have already
        reviewed many of the elements of financial information such as:

               q   Assets
               q   Liabilities
               q   Equity
               q   Revenues
               q   Expenses

        Other elements that will be explored in more detail in subsequent units include:

               q   Owner investments -- these could include common stock purchases for a corporation and
                   capital contributions for a sole proprietorship or partnership.
               q   Distribution to owners -- these are represented on financial statements by means of dividends
                   for a corporation and owner withdrawals for a sole proprietorship or partnership.
               q   Gains -- increases in equity from peripheral or incidental transactions or events other than
                   those that result from revenues or equity/net assets contributions
               q   Losses -- decreases in equity from peripheral or incidental transactions or events other than
                   those that result from expenses or distributions of equity/net assets




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Unit 1: Foundation Review > GAAP


        GAAP

        Measurement & Recognition
        The bottom of our financial concepts pyramid shows the assumptions, principles and constraints that
        will be applied when preparing financial information so that it is useful to decision makers. These
        concepts will help us in measuring and recognizing the financial information that will be reported.

        Note: For those new to accounting, slight differences in terminology may be confusing. The pyramid
        we are using to illustrate the accounting concepts has been broken down into assumptions, principles,
        and constraints to better illustrate their general characteristics. In practice you may also see these
        accounting concepts referred to as simply accounting principles.

        When preparing financial statements for a business entity, we assume that it is a:

               q   Separate entity
               q   Going concern

        Other assumptions include:

               q   Unit of measure
               q   Time period




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           Unit of Measure Assumes money, notentity, separate andan indefinite period
           Going Concern -- Every business is anassumed to be indefinite, thereforeor
           Separate Entity -- The business will continue toother asset such as beansits
           Time Period -- The life of a business is some operate for distinct from
           and its assets, other thanother usersof operations and the of toa specific time
           owner(s)reports are needed forbusiness.not beperformancefinancial position of a
           periodic and to measure inventory, to Economic but used one entity should
           steel, is used from every the results will judge sold events for generate income.
           business. It with these foranother measuring unit, assets as there is finally
           This justifiesalso assumes anot wouldn't be prepared until the businessno of is
           not be mixed the reason reports re evaluating capitalsuch that no adjustment the
           frame. Otherwise those of stable entity when determining performance
           intention to sell them. This does not hold true year intervalsofnot continuedeflation.
           entity. These time frames are purchasing power an entity willtoinflationannual
           ends.
           made for the monetary unit's often set at one if as a result      report or to
           operate,though themarket or liquidation values would start and to value all assets.
           results, and thus date at which the time period will be used end is often set
           arbitrarily. Interim reports, for example on a monthly basis, are also frequently
           prepared.




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Unit 1: Foundation Review > GAAP


        GAAP

        Measurement & Recognition
        Basic principles include:

               q   Cost principle
               q   Revenue recognition principle
               q   Matching principle
               q   Full-disclosure principle


       Cost principle -- based on unit of measure assumption of stable monetary unit,
       the cost used in valuation is historical cost (the cost on the date of acquisition). In
       cases where assets were obtained in a non cash transaction, fair values of the
       assets exchanged are considered. The cost principle is frequently overridden by
       relevancy issues such that assets may be reported at market values which may
       be more or less than their historical cost.


       Revenue recognition principle -- revenue is recognized when earned, not when
       received. Revenue is considered earned for goods when the risks of ownership
       have transferred to the buyer or for services when the service has been
       performed. Revenue will be recognized only if payment is assured.


       Matching principle -- Requires that expenses be recorded in the same period as
       the related revenue, not when incurred. When costs are incurred that relate to
       future benefits, these costs are not recognized as expenses until the time the
       benefit is recognized. Some costs, where future benefits are uncertain, such as
       advertising expenses, are recognized when incurred.


       Full-disclosure principle -- Because GAAP permits various alternatives, users
       must be made aware of which practices the business entity is using. Full
       disclosure is provided in the notes to the financial statements and enhances the
       reliability and relevance, and thus the usefulness, of the financial statements. The
       use of notes can also provide other helpful information not provided in the body
       of financial statements such as current market values of assets.




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Unit 1: Foundation Review > GAAP


        GAAP

        Measurement & Recognition (continued)

        When discussing relevance and reliability, we determined that often a trade-off was required when
        choosing between these two criteria.

        Therefore, when implementing accounting procedures, accountants must consider two constraints:

               q   Cost-benefit
               q   Materiality

        To effectively apply these constraints, the accountant must take care to understand how users will use
        the information in order to properly determine if the costs of producing information will outweigh the
        benefits or to judge if the amount is material to the user.



       Cost-benefit -- Evaluating the cost of producing financial information to determine if the benefits
       derived from having the information will outweigh the costs of producing or obtaining it.




       Materiality -- if an amount is determined to be not large enough to influence a user of the
       information, a more expedient way of producing the information may be undertaken. Justification is
       that the relevance or reliability of the financial information would not be materially important to the
       user.




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Unit 1: Foundation Review > GAAP


        GAAP

        Measurement & Recognition (continued)
        Let's test our understanding of these concepts with the following matching exercise. For each of the
        following scenarios, choose the concept that it violates from the choices listed below the scenarios.
        When you are finished, click done. Your responses will be marked and the correct choices shown.




        Correct Answer: B D E A C




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Unit 1: Foundation Review > GAAP


        GAAP

        Measurement & Recognition (continued)
        Before moving on to our last topic, let's complete this one with the following exercise. For each of the
        next statements, choose the correct assumption or constraint from the drop down box to complete the
        statement.




        Correct Answer:

        1. The materiality constraint.
        2. The time period assumption.
        3. The cost-benefit constraint.
        4. The unit of measure assumption.




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Unit 1: Foundation Review > Ethics


        Ethics

        Applying GAAP
        Maintaining ethical standards in accounting is necessary to ensure that financial statement users can
        rely on financial information as presented by accounting professionals.

        Unethical behaviour, such as insider trading, tax evasion, audit failure and fraud all contribute to a
        decline in public confidence in the accounting profession.

        In addition, there is concern that some accountants may compromise on accounting standards in order
        to gain other non-audit work such as management consulting and tax preparation.

        Technical competence in accounting is not enough -- choosing an alternative that does not truly reflect
        reality is unethical even though the method is acceptable under GAAP. Professional accountants
        cannot associate themselves with financial information they know, or should know, are false or
        misleading.

        CGA Canada's Code of Ethical Principles and Rules of Conduct provide standards of acceptable
        behaviour by its members. Some basic standards accountants must adhere to include:

               q   Confidentiality
               q   Competence
               q   Objectivity
               q   Integrity


       Confidentiality --                                       Objectivity -- Accountants
       Requirement that                                         must disclose all relevant
       accountants not disclose                                 information and provide
       any confidential                                         information that is
       information unless legally                               objective to enable users
       required to do so.                                       to make investment and
                                                                credit decisions on
                                                                information that is
       Competence --                                            accurate.
       Accountants have an
       ethical obligation to
       maintain both technical                                  Integrity -- Accountants
       competence and moral                                     must not only act in the
       competence (by keeping                                   best interest of their
       informed of and complying                                clients but of other indirect
       with acknowledged                                        users. They must
       standards of the                                         disassociate themselves
       profession in all areas in                               from information that is
       which the accountant                                     false or misleading.
       practices).




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Unit 1: Foundation Review > Ethics


        Ethics

        Applying GAAP (continued)
        The conceptual framework of accounting serves to guide accountants in applying the principles and
        assumptions that will result in relevant and reliable information for financial statement users.

        However, the conceptual framework also recognizes that no one method under GAAP is always
        appropriate. Accountants must therefore choose from among the alternatives allowed by applying
        professional judgement in an ethical manner to ensure statements are a fair representation of the
        results of operation and financial position of an organization.

        For financial information to have any real value, users must be able to assume that the accountant has
        acted ethically in preparation of the financial statements.




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Unit 1: Foundation Review > Test


        Test

        Congratulations on completing this unit.

        Try the following test to see how well you understand the concepts in this unit.

        Once you complete the test, you'll get feedback on how you did on each question. You can try this test
        multiple times, until you feel you are comfortable with the content.

        Once you have completed the test, you are ready to move on to the next unit.




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