1. Global Leadership University
Accounting basis
Lecture 2

2. ACCOUNTING PRINCIPLES
Accounting p
g principles
p
Revenue and Expense

3. CONCEPTUAL FRAMEWORK OF
ACCOUNTING
Generally accepted accounting p
y p g principles
p
set of standards and rules that are recognized as a
general guide for financial reporting
Financial Accounting Standards Board (FASB)
and Securities and Exchange Commission (SEC)
The FASB has the responsibility for developing
accounting principles.

4. ACCOUNTING INFORMATION
MUST BE USEFUL
To be
T b useful, information should possess
f l i f ti h ld
the following qualitative characteristics:
1 relevance
2 reliability
y
3 comparability
4 consistency

5. RELEVANCE
Accounting information has relevance if it
makes a difference in a decision.
Relevant information helps users forecast
future events (predictive value), or
it confirms or corrects prior expectations
(feedback l )
(f db k value).

6. RELIABILITY
Reliability f information means that the
R li bili of i f i h h
information is free of error .
To be reliable, accounting information must
be verifiable.

7. COMPARABILITY AND CONSISTENCY
Comparability means that the information should be
comparable with accounting information about other
enterprises.
Consistency means that the same accounting principles
C i i i i
and methods should be used from year to year within a
company.
2005 2006 2007

8. CHARACTERISTICS OF
USEFUL INFORMATION

9. THE OPERATING GUIDELINES OF
ACCOUNTING
Operating guidelines are classified as assumptions,
principles,
principles and constraints.
Assumptions provide a foundation for the accounting
process.
Principles indicate how transactions and other economic
events should be recorded.
Constraints on the accounting process allow for a relaxation of
the principles under certain circumstances.
Assumptions Principl Constrai
es nts
Monetary unit Revenue recognition Materiality
Economic entity Matching Conservatism
Time period
Full disclosure
Going concern
Cost

10. ASSUMPTIONS USED IN ACCOUNTING

11. ASSUMPTIONS
Monetary unit assumption:
only transaction data expressed in terms of money can be
included in the accounting records
Example: employee satisfaction and percent of
international employees are not transactions that
should be included in the financial records.
Employee Satisfaction
Should be Percentage of
included International Employees
ccou g
in accounting Salaries
S l i paid
id
records

12. ECONOMIC ENTITY
ASSUMPTION
Activities of the entity kept separate
and distinct from the activities of the owner
and all other economic entities.
d ll th i titi
Example: BMW activities can be
distinguished f
di ti i h d from th those of other
f th
car manufacturers such as Mercedes.

13. THE ENTITY CONCEPT EXAMPLE
Assume that John decides to open up a
p p g station
gas
and coffee shop.
The gas station made Revenues 250,000 in profits,
while the coffee shop lost Revenues 50,000.
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14. THE ENTITY CONCEPT EXAMPLE
How much money did John make?
y
At a first glance, we would assume that John made
Revenues 200,000.
However, by applying the entity concept we realize
that the gas station made Revenues 250,000 while the
coffee shop lost Revenues 50,000.
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15. GOING CONCERN
ASSUMPTION
The entity will continue
y
to operate in the future.

16. TIME PERIOD PRINCIPLE
For reporting purposes an
purposes,
organization’s life can be divided
into
i t separate accounting periods
t ti i d
months,
quarters,
years, etc.
years etc
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17. Exh.
3.1
THE ACCOUNTING PERIOD
Annual
1 2
Semiannual
1 2 3 4
Quarter
1 2 3 4 5 6 7 8 9 10 11 12
Month

18. REVENUE RECOGNITION PRINCIPLE
Revenue is generally recognized
At the time services are performed; or
p ;
When goods are sold and delivered to
a customer.
t
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19. REVENUE PRINCIPLE
Air & Sea Air & Sea
Travel, Inc. Travel, Inc.
I plan to have you
make my travel March 12 April 2
arrangements.
Situation 1 Situation 2
No transaction has occurred. The client has taken a trip arranged by
p g y
Air & Sea Travel. – Record Revenue19
– Do Not Record Revenue

20. THE MATCHING PRINCIPLE
The matching principle requires
that all expenses incurred to
generate the revenues recognized in
t th i di
an accounting period be matched
with those revenues.
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21. THE MATCHING PRINCIPLE
Another view . . .
Let the expense follow the revenue.
First the revenue . . .
Then th
Th the expense.
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22. GAAP RELATIONSHIPS IN REVENUE
AND EXPENSE RECOGNITION
Time Period
Time-Period Assumption
Economic life of business
can be divided into
artificial time periods
Revenue-Recognition
Principle Matching Principle
Expenses matched with
p
Revenue recognized i
R i d in
revenues
the accounting period in
in the same period when
which it is earned
efforts are expended to
generate revenues

23. Full Disclosure Principle
Illustration 1-14
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24. COST PRINCIPLE
The cost principle dictates that assets be
recorded at their cost.
cost
Cost= Purchase price + Preparing expenses

25. BASIC PRINCIPLES USED IN ACCOUNTING

26. CONSTRAINTS IN ACCOUNTING

27. Materiality Convention
A financial statement item is material if its omission
or misstatement would tend to mislead the reader of
the financial statements under consideration
Materiality often depends on the size of the organization –
what is material to one company might not be material to
another company.
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28. DUAL ASPECT CONCEPT
Accounting information is based on the double entry
g y
system.
Under this system, the two-sided effect of a
transaction is recorded in the appropriate accounts.
ASSETS = LIABILITIES + OWNER’S EQUITY
The Accounting Equation
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29. REVENUE AND EXPENSES
REVENUES are inflows of assets in exchange for p
g products and
services provided to customer as part of a company’s primary
operations.
EXPENSES are outflows of th using up of assets from
tfl f the i f t f
providing products and services to customer.
Profit
Profit= Revenue - Expenses

31. Revenue
Accrual Basis
Recognition
Accounting
Matching
M t hi
Principle

32. Yikes!! What
is Accrual
Basis
Accounting?

33. ACCRUAL BASIS ACCOUNTING
Revenues are recognized (recorded)
when earned, without regard to when
earned
cash is received;
Expenses are recorded as incurred
without regard to when they are
paid.
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34. ion
riodicity
96 97 98 99 00 01 02 03 04 05
umpti
Assu
? ? ? ? ? ?
Per
How do we recognize revenues?
⇒ The Revenue Recognition
Principle
How do we recognize expenses?
⇒ The Matching Principle
Accrual Basis Accounting

35. Bertha,
Bertha are
there any other
bases for
accounting?
Yikes! I don’t
know Claude We
Claude.
probably better ask
the professor!

36. CASH BASIS ACCOUNTING
With the cash basis . . .
Reve ues a e ecog ed the period
Revenues are recognized in t e pe od
cash is received; and
Expenses are recognized in the period
when cash is paid out.
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37. Bertha,
Bertha are
there any other
bases for
accounting?
Yikes! I don’t
know Claude We
Claude.
probably better ask
the professor!

38. MODIFIED CASH BASIS ACCOUNTING
With the Modified Cash Basis . . .
Current period revenues and expenses
are treated exactly as in the cash basis;
Expenses covering more than one
accounting period are allocated over the
useful life of the asset.
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