978-1118334324 Chapter 3 Lecture Note Part 2

2. Companies may initially credit revenues received in cash before being

recognized to a revenue account instead of a liability account. The

adjusting entry requires recording a liability for the portion still to be

recognized and debiting the revenue account so that its balance will

reflect the amount recognized.

*G. Discuss Financial Reporting Concepts.

1. To be useful, information should possess two fundamental qualities:

relevance and faithful representation.

decision scenario, it is relevant.

b. Accounting information is considered relevant if it provides information

that has predictive value – helps provide accurate expectations about

expectations.

c. Materiality is a company–specific aspect of relevance. An item is

material when its size makes it likely to influence the decision of an

investor or creditor.

(1) complete—nothing important has been omitted,

(2) neutral—is not biased toward one position or another, and

(3) free from error.

2. Enhancing Qualities – include comparability, consistency, verifiability,

timeliness, and understandability.

principles.

(1) To make a comparison, companies must disclose the

accounting methods used.

and methods from year to year.

c. Verifiable—quality of information that occurs when independent

measures obtain similar results.

loses its capacity to influence decisions.

e. Understandability—information presented in a clear fashion so

that users can interpret it and comprehend its meaning.

4. Economic Entity Assumption

 Every economic entity can be separately identified and accounted for.

 Economic events can be identified with a particular unit of accountability.

operation for the foreseeable future.

7. Measurement Principles – GAAP generally uses one of two measurement

principles: the historical cost principle or the fair value principle.

a. Historical Cost Principle – requires assets to be recorded at original

cost because that amount is verifiable.

b. Fair Value Principle – requires that assets and liabilities should be

reported at fair value (the price received to sell an asset or settle a

liability).

8. Full Disclosure Principle – requires that all circumstances and events

disclosed.

9. Cost Constraint – determining whether the cost that companies will

incur to provide the information will outweigh the benefit that financial

statement users will gain from having the information available.

IFRS

A Look at IFRS

It is often difficult for companies to determine in what time period they should

report particular revenues and expenses. Both the IASB and FASB are working

on a joint project to develop a common conceptual framework, as well as a

revenue recognition project, that will enable companies to better use the same

principles to record transactions consistently over time.

KEY POINTS

 In this chapter, you learned accrual-basis accounting applied under GAAP.

the period in which events occur.

 Similar to GAAP, cash-basis accounting is not in accordance with IFRS.

 IFRS also divides the economic life of companies into artificial time periods.

Under both GAAP and IFRS, this is referred to as the time period

assumption.

statements, including comparative information annually.

 The general revenue recognition principles required by GAAP that are used

in this textbook are similar to those under IFRS.

 Revenue recognition fraud is a major issue in U.S. financial reporting. The

same situation occurs in other countries, as evidenced by revenue

permitted under GAAP.

 The terminology used for revenues and gains, and expenses and losses,

differs somewhat between IFRS and GAAP. For example, income under

IFRS is defined as:

Increases in economic benefits during the accounting period in the form

from shareholders.

Income includes both revenues, which arise during the normal course of

operating activities, and gains, which arise from activities outside of the

shareholders.

Note that under IFRS, expenses include both those costs incurred in the

normal course of operations, as well as losses that are not part of normal

operations. This in contrast to GAAP, which defines each separately.

LOOKING TO THE FUTURE

accounting in this area.

20 MINUTE QUIZ

Circle the correct answer.

True/False

1. Since companies find it desirable and necessary to report the results of their activities

be divided into artificial time periods.

True False

2. The revenue recognition principle requires that companies recognize revenue in the period

True False

4. Payments of expenses that will benefit more than one accounting period are referred to

as prepaid expenses.

True False

5. Cost less accumulated depreciation is a measurement of the current value of an asset

such as equipment or a building.

True False

6. Depreciation is the process of allocating the cost of an asset to expense over its useful

life in a rational and systematic manner.

True False

7. The adjusting entry for unearned revenues results in a debit to an asset account and a

credit to a revenue account.

True False

8. A contra-asset account is an account whose balance is deducted from a related asset in

the financial statements.

True False

9. When accrual-basis accounting is applied, adjusting entries are not necessary.

True False

10. Adjustments for accrued expenses are necessary to record the obligations that exist at

the balance sheet date and to recognize the expenses that are applicable to the current

accounting period.

True False

Multiple Choice

1. The recording of salaries and wages earned but not yet paid is an example of an

adjustment that

a. recognizes an accrued expense.

b. recognizes an unrecorded revenue.

c. apportions revenues between two or more periods.

d. apportions costs between two or more periods.

2. A list of the accounts and their balances after all adjustments have been made is known as

a. adjusting entries.

b. adjusted trial balance.

c. book values.

d. accrued accounts.

3. Prior to recording adjusting entries, revenues exceed expenses by $60,000. Adjusting

a. $60,000.

b. $50,000.

c. $40,000.

d. none of the above.

4. The adjustment for depreciation is an example of

a. recognizing an accrued expense.

d. recognizing an unrecorded revenue.

5. Most businesses choose fiscal years which correspond to

a. the calendar year.

b. any twelve-month period.

c. their natural business year.

d. any of the above.

ANSWERS TO QUIZ

True/False

Multiple Choice