Chapter 4 Accounting

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Western University
Business Administration
Business Administration 4407Q/R/S/T

IFRS and ASPE Qualitative Characteristics  4 attributes financial information should have if it’s to be useful to stakeholders  1. Understandability – information is provided for moderately skilled audience (ie. People with a reasonable understanding of business and accounting and a willingness to study the information)  2. Comparability – important for stakeholders to compare the financial statements of the company over time and with those of other entities. To help achieve this IFRS requires entities to: o Disclose their accounting policies o Disclose any changes to their accounting policies (but no need to disclose changes in estimates) o Provide information about previous periods in their financial statements  3. Relevance – information is relevant if it influences stakeholder decisions and helps in making predications o However, financial statements are backwards looking and difficult to make predictions unless stable and established company  4. Reliability – representative of the entity’s underlying economic activity and free of bias and material error. o However, we have seen that much bias creeps into accounting decisions and policies Unfortunately, there are conflicts amongst the characteristics. Generally reliability wins out over relevance (ie. Historic Cost principle when purchase assets). Under IFRS, trying to address this conflict by allowing writing up of assets to market values. Revenue Recognition Revenue Recognition  An economic gain earned by an entity from providing goods and services to customers  The issue is when does this economic gain actually “happen” – or get “recognized” in the financial statements. This decision impacts the amounts reported in the financial statements, financial ratios and possibly people’s perceptions of how the entity is performing. 2 different approaches to recognizing revenue 1. Critical-Event Approach 2. Gradual Approach The Critical Event Approach  Identifies a particular point in the earnings process as the appropriate time to recognize revenues. This point is called the critical event (completion of production, delivery, after delivery if there are warranty, returns or collection issues and reasonable estimate can’t be made)  At the critical event, 100% of the revenue is recognized Guidelines for Revenue Recognition under IFRS and ASPE  5 criteria that should be met under ASPE and IFRS to recognize revenue 1. Performance has occurred and the significant rights and risks of ownership have been transferred to the buyer 2. The seller has no involvement or control over the goods sold 3. Collection of payment can be reasonably assured 4. The amount of revenue can be reasonably measured 4. Costs of earning the revenues can be reasonably measured NOTE: As we will see, many times these are not hard and fast rules and judgment and estimates are involved in deciding answers to above as terms are not clearly defined and this makes revenue recognition policies susceptible to bias. (ie. What is significant, what is reasonable?)  First 2 criteria are performance criteria – usually met once customer purchases goods and takes delivery unless o Buyer has to resell the merchandise before the seller gets paid (ie. Consignment goods) o The seller has to install the goods and the installation is a significant part of the purchase  Third criteria is collectability – must have a reasonable expectation of getting paid or a reasonable estimate of how much can be collected must be able to be made  Criteria 4 and 5 deal with measurability – the entity must be able to estimate the amount it has earned and the costs incurred to earn it (matching critiera). -example warranty costs – if can’t properly estimate can’t recognize the revenues -other example is returns Also, remember at the end of the day, the critical even should provide a reasonable and fair representation of the entity’s activities (but once again how do we interpret “reasonable” and “fair”. Overall, there is a general bias to be more conservative and delay recognition of revenues under IFRS to reduce uncertainty and make the f/s more “reliable”, however also not practical to wait until all uncertainty is resolved. Choices need to be made. Review question for consideration pg.173 The Gradual to recognizing revenues:  Often used when the entity provides services or signs long-term contracts that span longer then one accounting period.  Under this approach we recognize revenues little by little as the project or services are rendered. 1.Percentage of Completion Method  Widely used in construction and service industries (ie. long- term contracts and management consulting contracts) o Recognize revenue throughout the entire production process rather than waiting until the point of delivery o Use when revenue is known with reasonable margin or error and costs of completion are also known or can be estimated (ie. revenue recognition criteria can be met) o On any given contract, the proportion of total contract price to be recognized as revenue in each accounting period is the percentage of the total product completed during that period Revenue for the period =cost incurred during the periox Estimated revenue Total estimated cost for the project for the project o Consi
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