Chapter 4 – Accrual Accounting, Adjusting Entries, and Accounting Cycle
Recognition – The process of including an item in the financial statements of an entity.
Recognition consists of the addition of the amount involved into statements totals together
with a narrative description of the item in a statement. Examples: Inventory, Sales,
Donations) Shareholders, bankers, and other creditors have limited access to relevant
information about a company. They depend on the periodic financial statements issued by
management to provide necessary information to make their decisions. The process by
which the accountant depicts, or describes, the effects of economic events on the entity is
Measurement – Measurement of an item in financial statements requires that two choices
be made. First the accountant must decide on the attribute to be measured. Second, a scale
of measurement, or unit of measure, must be chosen.
The Attribute to Be Measured – The cost of the asset at the time it is acquired is the
most logical choice. Cost is the amount of cash, or its equivalent, paid to acquire the asset.
The simplest approach is to show the property on the balance sheet at its original cost, thus
the designation historical cost. The use of historical cost is not only simple but also
verifiable. An alternative to historical cost as the attribute to be measured is realizable
value. Realizable value is the amount of cash, or its equivalent, that could be received
currently from the sale of the asset. For the company’s piece of property, realizable value is
the estimated selling price of the land, reduced by any commissions or other fees involved in
making the sale. Two accountants might not necessary arrive at the same realizable value
for the land – depends on the banker lending money to you. Historical cost is the attribute
used to measure many of the assets recognized on the balance sheet.
The Unit of Measure – The use of the dollar as a unit of measure for financial
transactions is widely accepted. Example: The Land. Measure with square meters; will
never change. Worth value is measured with money which is $10,000 and it will not always
have the same purchasing power. Inflation, or a rise in the general level of prices in the
economy, results in a decrease in purchasing power.