Chapter 2 Accounting Principles

2 The Financial Accounting Standard's Board(FASB) developed a conceptual framework. It serves as the basis for resolving accounting and reporting problems.

3 The FASB’s conceptual framework consists of four items: 1. Objectives of Financial Reporting 2. Qualitative Characteristics of Accounting Information Information 3. Elements of Financial Statements 4. Operating Guidelines(Assumptions, Principles, and constraints) Principles, and constraints)

2-1 Conceptual Framework CONSTRAINTS Objectives of Financial Reporting Qualitative Characteristics of Accounting Information Elements of Financial Statements Operating Guidelines AssumptionsPrinciples CONSTRAINTS

5 Objectives of Financial Reporting Financial Reporting should have three objectives: 1.The information is useful to those making investment and credit decisions. 2.The financial reports are helpful in assessing future cash flows. 3.The economic resources(assets), the claims to those resources(liabilities), and the changes in those resources and claims are clearly identified.

2-2 Qualitative Characteristics of Accounting Information UsefulFinancial Information has: 1. Predictive value 2. Feedback value 3. Timely Relevance 1. Verifiable 2. Faithful representation 3. Neutral Reliability ComparabilityandConsistency

7 Relevance 1. Relevant information has either Predictive or feedback value or both. Predictive or feedback value or both. -Predictive value helps users forecast future events. -Feedback value confirms or corrects prior expectations. 2. Accounting information has relevance if it is timely. is timely.

8 Reliability 1. Reliability of information means that the information is free of error and bias. - Verifiable: We must be able to prove that it is free of error and bias. - Verifiable: We must be able to prove that it is free of error and bias. - Faithful representation: It must be factual. - Faithful representation: It must be factual. - Neutral: It cannot be selected, prepared, - Neutral: It cannot be selected, prepared, or presented to favor one set of interested or presented to favor one set of interested users over another. users over another.

9 Comparability 1. Accounting information about an enterprise is most useful when it can be compared with accounting information about other enterprises. 2.Comparability results when different companies use the same accounting principles.

10 Consistency Consistency means that a company uses the same accounting principles and methods from year to year.

2-3 Operating Guidelines Detailed Guidelines for Solving Practical Problems 4. Going Concern 3. Time Period 2. Monetary Unit 1. Economic Entity 4. Cost 3. Full Disclosure 2. Matching 1. Revenue Recognition MaterialityConservatism CONSTRAINTSand ASSUMPTIONSPRINCIPLES

12 Accounting reports, called financial statements, provide summarized information to the owner. Accounting Principles

13 The excess of revenue over the expenses is called net income or net profit. If the expenses exceed the revenue, the excess is a net loss.

The income statement is a summary of the revenue and expenses for a specific period of time, such as a month or a year. 14

15 The income statement reports the revenues and expenses for a period of time based on the matching concept. This concept is applied by matching the expenses with the revenue generated during a period by those expenses. Income Statement

16 Net income is carried to the statement of owner’s equity Income Statement

17 A statement of owner’s equity is a summary of the changes in the owner’s equity that have occurred during a specific period of time.

18 The statement of owner’s equity reports the changes in the owner’s equity for a period of time. It is prepared after the income statement. Statement of Owner’s Equity

19  The income statement and the statement of owner’s equity are interrelated. Net income or net loss appears on both statements. Interrelationships Among Financial Statements

20 From the income statement To the balance sheet Statement of Owner’s Equity

21 A balance sheet is a list of the assets, liabilities, and owner’s equity as of a specific date.

22  The statement of owner’s equity and the balance sheet are interrelated. The owner’s capital at the end of the period on the statement of owner’s equity also appears on the balance sheet as owner’s capital.

23 This amount is compared to the net cash flow on the statement of cash flows From the statement of owner’s equity Balance Sheet

24 This amount should match Cash on the balance sheet. Statement of Cash Flows

25 The account form of balance sheet lists the assets on the left and the liabilities and owner’s equity on the right—similar to design of an account.account form

26 The report form of balance sheet presents the liabilities and owner’s equity sections below the assets section.report form

27 A statement of cash flows is a summary of the cash receipts and payments for a specific period of time.

28  The balance sheet and the statement of cash flows are interrelated. The cash on the balance sheet also appears as the end-of-period cash on the statement of cash flows.

29 The statement of cash flows consists of three sections: (1)Operating activities (2)Investing activities (3)Financing activities Statement of Cash Flows

30 The cash flows from operating activities section reports a summary of cash receipts and cash payments from operations.cash flows from operating activities

31 The cash flows from investing activities section reports the cash transactions for the acquisition and sale of relatively permanent assets.

32 The cash flows from financing activities section reports the cash transactions related to cash investments by the owner, borrowings, and cash withdrawals by the owner. Financial Statements