SESSION 4 by shrakdoc


									The Measurement Fundamentals of
     Financial Accounting

   Electronic Presentations for Chapter 4
Key Points
   Four basic assumptions of financial accounting.
   The markets in which business entities operate and the
    valuation bases used on the balance sheet.
   The principle of objectivity and how it determines the
    dollar values that appear on the financial statements.
   The principles of matching, revenue recognition, and
   Two exceptions to the principles of financial accounting
    measurement: materiality and conservatism.
Basic Assumptions
   Economic entity
   Fiscal period
   Going concern
   Stable dollar
Economic Entity
   A 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, General
    Electric and NBC.
Fiscal Period
   It 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.
Going Concern
   The life of an economic entity is
    assumed to be indefinite.
   Assets, defined as having future
    economic benefit, require this
Stable Dollar
   The 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.
   This is considered an unrealistic assumption
    and thus places a limit on the financial
    statements as a tool for analysis.
Valuations on the
Balance Sheet
   Input market
    – Purchase of materials, labor, overhead
   Output market
    – Sales of services or inventories
   Alternative valuation bases
    – Present value
    – Fair market value
    – Replacement cost
    – Original cost
Present Value
as a Valuation Base
   Discounted future cash inflows and
   For 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
Fair Market Value
as a Valuation Base
   Sales price or the value of goods and
    services in the output market.
   For example, accounts receivable are
    valued at net realizable value which
    approximates fair market value.
Replacement Cost
as a Valuation Base
   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.
Original Cost as a
Valuation Base
   Input price paid when originally
   For example, land and property used in
    a company’s operations are all valued
    at original cost.
Principles of Financial
Accounting Measurement
   Objectivity
   Matching
   Revenue recognition
   Consistency
The Objectivity Principle
   This 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.
The Revenue
Recognition Principle
   This principle determines when revenues can
    be recognized.
   This principle triggers the matching principle,
    which is necessary for determining the
    measure of performance.
   The most common point of revenue
    recognition is when goods or services are
    transferred or provided to the buyer.
The Matching Principle
   This principle states that the efforts of a
    given period should be matched against
    the benefits they generate.
   For example, the cost of inventory is
    capitalized as an asset on the balance
    sheet and not recorded in Cost of
    Goods Sold until sold.
The Matching Process

  Incur cost
The Matching Process

  Incur cost   revenue is
The Matching Process


                 Period         Current
  Incur cost   revenue is       period
The Matching Process


  Incur cost   revenue is
               generated?        Future

The Matching Process


  Incur cost   revenue is     ????

The Consistency Principle
   Generally 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.
Exceptions to the
Basic Principles
   Materiality
    – Only transactions with amounts large enough to
      make a difference are considered material.
    – Nonmaterial transactions are ignored
   Conservatism
    – When in doubt
       •   Understate assets
       •   Overstate liabilities
       •   Accelerate recognition of losses
       •   Delay recognition of gains

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