Accounting principles assumptions

Constraints in Accounting Conservatism ● Concept: You should record expenses and liabilities as soon as possible, but to record revenues and assets only when you are sure that they will occur => NOT overstate revenue/assets, NOT understate expenses/liabilities ● Tends to encourage the recordation of losses earlier, rather than later => Business persistently misstates its results to be worse than reality ● The constraint of conservatism: when preparing financial statements, a company should choose the accounting method that will be least likely to overstate assets and income ● The writing down of inventory to market follows the constraint of conservatism ● Application: Selecting the method or procedure that yields less net income Cost constraint: weighs the cost that companies will incur to provide the information against the benefit that financial statement users will gain from having the information available Accounting assumptions Economic entity assumption ● Economic events can be identified with a particular unit of accountability ● States that economic events of every entity can be separately identified and accounted for (Tuyên bố rằng các sự kiện kinh tế của mỗi đơn vị có thể được xác định và hạch toán riêng biệt) ● Indicates that personal and business recordkeeping should be separately maintained ● Tracing accounting events to particular companies (Truy tìm các sự kiện kế toán cho các công ty cụ thể) ● Prevents intermingling (trộn lẫn vào nhau) of assets and liabilities among multiple entities Going concern assumption ● Concept: a business has a reasonable expectation of remaining in business/operation for the foreseeable future (một doanh nghiệp có kỳ vọng hợp lý về việc duy trì hoạt động kinh doanh/hoạt động trong tương lai gần) ● Is the rationale for why plant assets are not reported at liquidation value. (Note: Do not use the historical cost principle) ● You would be justified in deferring (hoãn) the recognition of some expenses until later periods Time period assumption ● A business should report the results of its operations over a standard period of time ● States the life of a business can be divided into artificial time periods and that useful reports covering those periods can be prepared ● Separates financial information into time periods for reporting purposes ● The practice of preparing financial statements at regular intervals Monetary unit assumption ● Assumes that the monetary unit is the “measuring stick” used to report on financial performance. ● A business should only record transactions that can be stated in terms of a unit of currency (Doanh nghiệp chỉ nên ghi lại các giao dịch có thể được thể hiện dưới dạng đơn vị tiền tệ). ● Keeps a business from engaging in an excessive level of estimation in deriving the value of its assets and liabilities Accounting principles GAAP: The rules and practices that are recognized as general guides for financial reporting Accrual-basis accounting ● Company records transactions in the period in which the events actually occur, rather than in the periods when there are cash flows associated with them ● Companies recognize revenues when they perform services (rather than when they receive cash) and recognize expenses when incurred (rather than when paid) Cash-basis Accounting ● Revenues are recorded when cash is received ● Expenses are recorded when cash is paid ● NOT in accordance with GAAP Historical Cost principle or Cost principle ● Dictates that companies should record assets at their orginal purchase cost => less valid ● Requires that when asset are acquired, they be recorded at the amount paid for them ● Measurement basis used when a reliable estimate of fair value is not available. Fair Value principle: States that assets and liabilities should be reported at fair value (the price received to sell an asset or settle a liability) Full disclosure principle ● Dictates that companies should disclose all circumstances and events (report all information) that make a difference to financial statement users (Yêu cầu các công ty phải tiết lộ tất cả các trường hợp và sự kiện (báo cáo tất cả thông tin) có ảnh hưởng khác biệt đến người sử dụng báo cáo tài chính) ● You should include in or alongside the financial statements all of the information that may impact a reader's understanding of those statements Revenue recognition principle: Companies recognize revenue in the accounting period in which the performance obligation is satisfied Expense recognition principle: Dictates that companies recognize expense in the period in which they make efforts to generate revenues “Let the expenses follow the revenues” Matching principle ● When you record revenue, you should record all related expenses at the same time ● You charge inventory to the COGS at the same time that you record revenue from the sale of those inventory items ● This is a cornerstone of the accrual basis of accounting (Đây là nền tảng của cơ sở dồn tích của kế toán) ● The cash basis of accounting does not use the matching the principle Reliability principle ● Only those transactions that can be proven should be recorded (e.g. Supplier invoice) ● Of prime interest to auditors (in search of the evidence supporting transactions) ● Qualities of Useful Information Relevance ● Information that makes a difference in/ has a bearing on a decision ● Information that has predictive value (accurate expectations about the future), and has confirmatory value (confirms or corrects prior expectations) Materiality (Trọng yếu) - A company-specific aspect of relevance ● Refers to items in financial statements that are likely/important enough to influence decision of a reasonably prudent investor or creditor ● Concerning whether an item’s size is large enough to matter to decision makers ● To determine the materiality of an account, an accountant would compare it with total assets, total liabilities, net income ● Applications o The practice of large corporations reporting all financial statement amounts to the nearest thousand dollars o Expensing the purchase of a waste paper basket with an estimated useful life of 10 years o A practical decision to expense small capital expenditures rather than record them as property, plant, and equipment and depreciate them probably is made on the basis of the characteristic of materiality Faithful Representation ● Information accurately depicts what really happened ● Information must be complete (nothing important has been omitted), neutral (not biased), and free from error ● The desire to minimize bias in financial statements Enhancing qualities Comparability: When different companies use the same accounting principles => Ability to easily evaluate one company’s results relative to another’s Consistency: Same accounting principles and methods used from year to year within a company Accounting terms Earnings per share = Net income - preferred stock dividends divided by average common shares out-standing Free cash flow ● Cash from operating activities less capital expenditures and cash dividends ● A measurement to provide additional insight regarding a company's cash-generating ability Intangible assets: Noncurrent assets that do not have physical substance Current assets: Assets that are expected to be converted to cash or used in the business within a relatively short period of time Working capital: the excess of current assets over current liabilities Current ratio = current assets divided by current liabilities Liquidity ratio: measures of the short-term ability ofthe enterprise to pay its maturing obligations Solvency ratios: measures of the ability of the enterprise to survive over a long period of time