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Chapter 2

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University of Toronto Scarborough
Financial Accounting

Chapter 2 Accounting Assumptions separate-entity assumption -the activities of each business must be accounted for as an individual organization that is separate and apart from its owners, all other persons, and other entities. e.g. the activities of each business must be accounted for as an individual organization that is separate and apart from its owners, all other persons, and other entities. unit-of-measure assumption- business entity accounts for and reports its financial results primarily in terms of the national monetary unit even if the entity has business operations in many countries. accountants assume that the unit of measure has a stable value over time. this allows accounts to combine different amount despite change in purchasing power of that unit. continuity assumption ( going-concern assumption)- a business normally is assumed to continue operating long enough to carry out its objectives and to meet contractual commitments. Called going-concern because business is expected to continue into foreseeable future. violation leads to assets and liabilities to be values on balance sheet as if liquidated Basic Accounting Principle historical cost principle states- the cash-equivalent cost needed to acquire an asset (the historical cost) should be used for initial recognition (recording) of all financial statement elements. the cost principle- cost is measured on the date of the transaction as the cash paid plus the current monetary value of all non-cash considerations (any assets, privileges, or rights) also given in the exchange. advantage many assets are acquired through legal contracts that states the acquisition cost. E.G. trade computer and cash for car, the cost of car = cash + market value of computer. Disadvantage- continued reporting of historical cost on statements does not reflect change in market value, market value is less verifiable than historical cost. accounts rely on historical cost measures for reporting since they are factual, but not useful for specific decision-making processes. Elements of the Classified Statement of Financial Position Assets- economic resources controlled by an entity as a result of past transactions or events and from which future economic benefits may be obtained. external users care about assets since they represent future financial benefits. lenders interpret assets as how readily they can repay financial obligations. shareholders look at the realized benefits arising from company control assets. specific classifications of information included to make financial statements more useful to investors creditors and analysts. slightly different formats Consolidated statement of financial position- includes classified elements of company combined with other companies under its control. e.g. Haagen-Dazs of Nestle's. Two amounts from two different years are shown so that investors can compare value of classified elements from year to year in order to analyze the changes to understand the change in financial position. (Exhibit 2.2) Exhibit 2.2 explained: amounts rounded to the nearest million swiss francs. fiscal year ends on Dec 31st. Typical assets of company: 2. Non-current assets (long-term) 1. Current assets (short-term) a. Property, plant, and equipment (at cost less accumulated a. Cash and cash equivalents depreciation) b. Short-term investments b. Investment in associates c. Trade and other receivables c. Financial assets d. inventories d. Goodwill e. Prepayments(i.e. expense paid in advance of use) e. Intangible assets f. other current assests. f. Other (miscellaneous) assets. ASSETS divided into 2 subgroups: current and non-current. Current assets- a.k.a. short term assets. economic resources that typically transform into cash or use within a year or business cycle *assets listed in order of liquidity: how soon can be transformed into cash. Cash and cash equivalents appear first. (cash equivalent includes rime deposits, placements in commercial paper with original maturities of three months or less.) Short-term investments- reported values for shares of other companies + other financial instruments as investment of excess cash. Trade and other receivables consists of mostly trade receivables- amounts owed by customer who purchased on credit. (normally collected within one year of statement date.)Notes receivable- written promises by customer/other to pay company fixed amounts by specified dates. inventories- goods that (1) are held for sale to customers in the normal course of business. (2) are used to produce goods or services for sale. (inventories always considered current asset. ) Prepayments- (e.g., insurance premiums and rent paid in advance for use of a building) reflect available benefits (e.g., monthly insurance protection, office space) that the company will use within one year Other current assets- include a number of assets with smaller balances that are combined. non-current assets- These assets are considered to be long-term because they will be used or turned into cash over a period longer than the next year Property, plant, and equipment -all land, buildings, machinery, and equipment such as tools, furniture, and other fixtures that will be used for the production, packaging, and storage also called fixed assets or capital assets. Have physical form that can be touched. tangible asset. investment in associates- purchase of shares issued by other corporations for exercising significant influence over investing, financing, and operating decisions. e.g. nestle owned 30% shares of L'Oreal, resulted in influence of decisions made by L'O
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