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Chapter 2 (5 pages of thorough notes for midterm exam).docx

5 Pages

Course Code
ACTG 3110
Elizabeth Farrell

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Chapter 2: Accounting Judgments Categories of Accounting Concepts Underlying assumptions – basic foundation upon which accounting measurement rests Qualitative characteristics (qualitative criteria) – criteria that’s used to evaluate the options and choose the best methods for a given situation – why Measurement methods – different ways financial position and results can be reported (historical cost, revenue recognition) – how Historical cost is used (measurement method) because it is verifiable (qualitative) To construct financial statements, we must:  Determine the objectives of financial report  Make sure the underlying assumptions are valid  Measure the elements of financial statements using situation-specific measurement methods that satisfy the qualitative criteria  Prepare the financial statements Accounting choices for measurement and reporting: 1. Underlying assumptions 2. Qualitative Criteria 3. Accounting choices a. Measurement methods b. Recognition and realization c. Financial statement elements Ethical Professional Judgment in Accounting Professional judgment – process of making choices in accounting – being able to rely on judgment in preference to stipulating rigid rules. It takes into account:  Users and their specific information needs  Motivations of managers  Organization’s operations  Organization’s reporting constraints Underlying Assumptions Can be grouped into 2 general categories: 1. Universal assumptions – essential in order to make reports feasible and meaningful 2. Entity-specific assumptions – very common, but depend on individual entity Universal assumptions: 1. Time period – information can be assembled and reported for a time period that is less than the enterprise’s life span (you are able to make estimates) 2. Separate entity – enterprise can be accounted for independent of its owners (cases where owner lends to the business – debtor/creditor relationship) 3. Unit of measure – results can be quantified into monetary terms (customer goodwill, human capital, environmental benefits, cannot be quantified) Entity-specific assumptions: 4. Continuity – enterprise will operation for a reasonable future period Not valid when:  It is a limited-life venture  About to go bankrupt o Liquidation accounting – assets and liabilities are valued at estimated net realizable value 5. Proprietary approach – results should be reported from the viewpoint of its owners Proprietary concept – financial condition is reported from the owner’s perspective – so the owner keeps profit that is realized Entity concept – owners are one of many participants. The wealth that is generated is reinvested into the company and it is the corporation itself that benefits 6. Stable currency – value of measurement currency doesn’t change yearly Purchasing power parity – relative values of currencies will adjust to maintain their purchasing power Capital maintenance – preserving capital investments Nominal dollars – unadjusted for purchasing power (inflation) Capital Maintenance Approaches Constant dollar capital maintenance – recognizes that not all dollars are equal – more nominal dollars have to be invested each year just to remain constant in real value Productivity capacity capital maintenance – must be able to maintain same level of service/productivity – not equivalent dollars Physical capital maintenance – profits are reported only after the entity keeps enough capital to replace the assets used (not used very often) Qualitative Criteria Fundamental qualities: Relevance – accounting information must be useful for decisions 1. Predictive value – increase ability to forecast future events 2. Confirmatory value – should help decision-makers who are confirming past predictions or making updates, adjustments, or corrections to predictions Representational Faithfulness – represent what it sets out to represent (accuracy) Substance over form – taking a deeper look into what is going on (example: a lease is normally a rental – rent expense – but if its being used like a purchase, then it should be reported as an asset regardless)  Completeness – information should not mislead or deceive – facts  Neutrality – don’t influence a user’s decision to achieve an outcome  Freedom from material error – estimates based on best available information (free from bias) Enhancing Qualities: Comparability – factor when considering relationship between two pieces of info.  Consistency – applying concepts period-to-period in the same manner  Uniformity – various companies should use same accounting methods for same economic events Verifiability – independent observers can measure an economic event and get the same result. 2 aspects to it:  Accounting measure is a reasonable measure of the economic event  Using the same measurement methods, we would reach similar conclusion Timeliness – it should be reported soon enough so it’s useful Understandability – understandable to users to help decision-making process (not dumbed down completely, but enough so the average investor can understand it) Pervasive Constraints: Materiality – used to describe the significance of an item (would omission matter?) Arbitrary limit of 5% of income from continuing operations is often benchmarked Cost/Benefit Tradeoff – any accounting measurement of disclosure should result in greater benefits to the user than the cos
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