Development of Accounting

Principles and Professional

Practice
The Environment Of Financial
Accounting
 The environment of financial accounting

• Essential characteristics of accounting are:

1. the identification, measurement, and communication of financial
information about

2. economic entities to

3. interested parties- External users

As an information system, it involves the following steps:

• Identifying, measuring, analyzing and recording ,
classifying, summarizing, reporting, interpreting
 Users of accounting information
– Internal Users
• mainly management personnel of an
organization
• need very detailed and specific information
about activities of an entity
–External Users
• consist of decision makers outside the
reporting economic entity
• are not directly involved in the day-to-day
activities
 OBJECTIVE OF FINANCIAL
ACCOUNTING
• Objective: Provide financial information about the
reporting entity that is useful to
► present and potential equity investors,

► lenders, and

► other creditors

– in making decisions about providing resources to the entity.

OBJECTIVE OF FINANCIAL ACCOUNTING

General-Purpose Financial Statements

► Provide financial reporting information to a wide
variety of users.
► Provide the most useful information possible at the
least cost.

Equity Investors and Creditors

► Investors and creditors are the primary user group.

LO 5
OBJECTIVE OF FINANCIAL ACCOUNTING

Entity Perspective
► Companies viewed as separate and distinct from their
owners (shareholders).

Decision-Usefulness
► Investors are interested in assessing
1. the company’s ability to generate net cash inflows and
2. management’s ability to protect and enhance the capital
providers’ investments.

LO 5
 General Purpose Financial Statements

 provides information via annual financial

statements
 financial statements provide highly
summarized information about the affairs of a
company as a whole
 general purpose financial statements are
prepared based on IFRS or GAAP, individual
users do not have the power to prescribe the
format and content of general purpose
financial statements
 STANDARD-SETTING ORGANIZATIONS

Main international standard-setting organization:

► International Accounting Standards Board (IASB)

● Issues International Financial Reporting Standards (IFRS)

.

● Standards used on most foreign exchanges.

● IFRS used in over 115 countries.

● Organizations that have a role in international standard-

setting are the International Organization of Securities
Commissions (IOSCO) and the IASB.

LO 6
 STANDARD-SETTING ORGANIZATIONS

International Organization of Securities

Commissions (IOSCO)
► Does not set accounting standards.

► Dedicated to ensuring that global

markets can operate in an efficient
and effective basis.
http://www.iosco.org/
► Supports the use of IFRS as the
single set of international
standards in cross-border offerings
and listings.

LO 6
 STANDARD-SETTING ORGANIZATIONS

International Accounting Standards Board (IASB)

Composed of four organizations—

► IFRS Foundation
► International Accounting Standards Board (IASB)
► IFRS Advisory Council
► IFRS Interpretations Committee

LO 6
International Accounting Standards Board
ILLUSTRATION 1-4
International Standard-Setting Structure

LO 6
 International Accounting Standards Board

Due Process
The IASB due process has the following elements:
1. Independent standard-setting board;
2. Thorough and systematic process for developing standards;
3. Engagement with investors, regulators, business leaders,
and the global accountancy profession at every stage of
the process; and
4. Collaborative efforts with the worldwide standard-setting
community.

LO 6
 International Accounting Standards Board

ILLUSTRATION 1-5
International
Standard-Setting
Structure

LO 6
 International Accounting Standards Board

Types of Pronouncements
► International Financial Reporting Standards.
► Conceptual Framework for Financial Reporting.
► International Financial Reporting Standards Interpretations.

LO 6
 STANDARD-SETTING ORGANIZATIONS

Hierarchy of IFRS
Companies first look to:
1. International Financial Reporting Standards; International
Financial Reporting Standards, International Accounting
Standards (issued by the predecessor to the IASB), and IFRS
interpretations originated by the IFRS Interpretations
Committee (and its predecessor, the IAS Interpretations
Committee);
2. The Conceptual Framework for Financial Reporting; and
3. Pronouncements of other standard-setting bodies that use a
similar conceptual framework (e.g., U.S. GAAP).

LO 7
 STANDARD-SETTING ORGANIZATIONS

Question
IFRS is comprised of:
a. International Financial Reporting Standards and FASB
financial reporting standards.
b. International Financial Reporting Standards,
International Accounting Standards, and International
Accounting Standards Interpretations.
c. International Accounting Standards and International
Accounting Standards Interpretations.
d. FASB financial reporting standards and International
Accounting Standards.
LO 7
 FINANCIAL REPORTING CHALLENGES
ILLUSTRATION 1-6

IFRS in a Political Environment User Groups that Influence the

Formulation of Accounting
Standards

LO 8
 FINANCIAL REPORTING CHALLENGES

The Expectations Gap

What the public thinks accountants should do vs. what
accountants think they can do.

Significant Financial Reporting Issues

► Non-financial measurements
► Forward-looking information
► Soft assets
► Timeliness

LO 8
 FINANCIAL REPORTING CHALLENGES

Ethics in the Environment of Financial Accounting

► Companies that concentrate on “maximizing the bottom

line,” “facing the challenges of competition,” and
“stressing short-term results” place accountants in an
environment of conflict and pressure.

► IFRS do not always provide an answer.

► Technical competence is not enough when encountering

ethical decisions.

LO 8
 FINANCIAL REPORTING CHALLENGES

International Convergence
Examples of how convergence is occurring:
1. China’s goal is to eliminate differences between its standards and
IFRS.
2. Japan now permits the use of IFRS for domestic companies.
3. The IASB and the FASB have spent the last 12 years working to
converge their standards.
4. Malaysia helped amend the accounting for agricultural assets.
5. Italy provided advice and counsel on the accounting for business
combinations under common control.

LO 8
 FINANCIAL REPORTING CHALLENGES

Question
The expectations gap is:
a. what financial information management provides and
what users want.
b. what the public thinks accountants should do and
what accountants think they can do.
c. what the governmental agencies want from standard-
setting and what the standard-setters provide.
d. what the users of financial statements want from the
government and what is provided.

LO 8
 GLOBAL ACCOUNTING INSIGHTS

INTERNATIONAL FINANCIAL REPORTING

Most agree that there is a need for one set of international accounting
standards. Here is why:
• Multinational corporations
• Mergers and acquisitions
• Information technology
• Financial markets
 GLOBAL ACCOUNTING INSIGHTS

Relevant Facts
Following are the key similarities and differences between U.S. GAAP and IFRS
related to the financial reporting environment.
Similarities
• Generally accepted accounting principles (GAAP) for U.S. companies are
developed by the Financial Accounting Standards Board (FASB). The FASB is a
private organization. The U.S. Securities and Exchange Commission (SEC)
exercises oversight over the actions of the FASB. The IASB is also a private
organization. Oversight over the actions of the IASB is regulated by IOSCO.
 GLOBAL ACCOUNTING INSIGHTS

Relevant Facts
Similarities
• Both the IASB and the FASB have essentially the same governance structure,
that is, a Foundation that provides oversight, a Board, an Advisory Council,
and an Interpretations Committee.
• The FASB relies on the U.S. SEC for regulation and enforcement of its
standards. The IASB relies primarily on IOSCO for regulation and
enforcement of its standards.
• Both the IASB and the FASB are working together to find common grounds
for convergence. A good example is the recent issuance of a new standard on
revenue recognition that both organizations support. Also, the Boards are
working together on other substantial projects such as the measurement
and classification of financial instruments.
 GLOBAL ACCOUNTING INSIGHTS

Relevant Facts
Differences
• U.S. GAAP is more detailed or rules-based. IFRS tends to simpler and more
flexible in the accounting and disclosure requirements. The difference in
approach has resulted in a debate about the merits of principles-based
versus rules-based standards.
• Differences between U.S. GAAP and IFRS should not be surprising because
standard-setters have developed standards in response to different user
needs. In some countries, the primary users of financial statements are
private investors. In others, the primary users are tax authorities or central
government planners. In the United States, investors and creditors have
driven accounting-standard formulation.
 GLOBAL ACCOUNTING INSIGHTS

About The Numbers

The IASB has looked to the United States to determine the structure it should
follow in establishing IFRS. Presented is the FASB’s standard-setting structure.
 GLOBAL ACCOUNTING INSIGHTS

On the Horizon
Both the IASB and the FASB are hard at work developing standards that will
lead to the elimination of major differences in the way certain transactions are
accounted for and reported. In fact, beginning in 2010, the IASB (and the FASB
on its joint projects with the IASB) started its policy of phasing in adoption of
new major standards over several years. The major reason for this policy is to
provide companies time to translate and implement international standards
into practice.
Much has happened in a very short period of time in the international
accounting environment. It now appears likely that in a fairly short period of
time, companies around the world will be close to using a single set of high-
quality accounting standards.
 Conceptual Framework for Financial Accounting
and Reporting
• Refers to the theoretical basis/foundation for financial
accounting and reporting
• Establishes the concepts that underlie financial
accounting and reporting.
• Provides a logical structure and direction to the
development of accounting standards and principles that
guide the practices of financial accounting and reporting
– The conceptual framework consists of
• objectives of financial reporting
• elements of financial statements
• qualitative characteristics of accounting
information
• recognition and measurement guidelines
 CONCEPTUAL FRAMEWORK

Overview of the Conceptual Framework

Three levels:
 First Level = Objectives of Financial Reporting

 Second Level = Qualitative Characteristics and

Elements of Financial Statements

 Third Level = Recognition, Measurement, and

Disclosure Concepts.

LO 2
 ASSUMPTIONS PRINCIPLES CONSTRAINTS
1. Economic entity 1. Measurement 1. Cost
2. Going concern 2. Revenue recognition
Third level
3. Monetary unit 3. Expense recognition
The "how"—
4. Periodicity 4. Full disclosure implementation
5. Accrual

QUALITATIVE
CHARACTERISTICS ELEMENTS
1. Fundamental 1. Assets
qualities 2. Liabilities Second level
2. Enhancing 3. Equity
Bridge between
qualities 4. Income
5. Expenses levels 1 and 3
ILLUSTRATION 2-7
Conceptual Framework
for Financial Reporting OBJECTIVE
Provide information
about the reporting
entity that is useful
to present and potential First level
equity investors,
lenders, and other
The "why"—purpose
creditors in their of accounting
capacity as capital
providers.
 FIRST LEVEL: BASIC OBJECTIVE

OBJECTIVE
“To provide financial information about the reporting entity
that is useful to present and potential equity investors,
lenders, and other creditors in making decisions about
providing resources to the entity.

 Provided by issuing general-purpose financial statements.

 Assumption is that users need reasonable knowledge of business
and financial accounting matters to understand the information.

LO 3
 SECOND LEVEL: FUNDAMENTAL CONCEPTS

Qualitative Characteristics of Accounting

Information
IASB identified the Qualitative Characteristics of accounting
information that distinguish better (more useful)
information from inferior (less useful) information for
decision-making purposes.

LO 4
SECOND LEVEL: FUNDAMENTAL CONCEPTS

ILLUSTRATION 2-2
Hierarchy of Accounting
Qualities

LO 4
 Relevance

ILLUSTRATION 2-7
Conceptual Framework
for Financial Reporting

LO 4
SECOND LEVEL: FUNDAMENTAL CONCEPTS

Fundamental Quality—Relevance

Financial information has predictive value if it has value as an input to

predictive processes used by investors to form their own expectations
about the future.

LO 4
SECOND LEVEL: FUNDAMENTAL CONCEPTS

Fundamental Quality—Relevance

Relevant information also helps users confirm or correct prior

expectations.

LO 4
SECOND LEVEL: FUNDAMENTAL CONCEPTS

Fundamental Quality—Relevance

Information is material if omitting it or misstating it could influence

decisions that users make on the basis of the reported financial
information.

LO 4
 Faithful Representation

ILLUSTRATION 2-7
Conceptual Framework
for Financial Reporting

LO 4
SECOND LEVEL: FUNDAMENTAL CONCEPTS

Fundamental Quality—Faithful Representation

Faithful representation means that the numbers and descriptions

match what really existed or happened.

LO 4
SECOND LEVEL: FUNDAMENTAL CONCEPTS

Fundamental Quality—Faithful Representation

Completeness means that all the information that is necessary for

faithful representation is provided.

LO 4
SECOND LEVEL: FUNDAMENTAL CONCEPTS

Fundamental Quality—Faithful Representation

Neutrality means that a company cannot select information to favor one

set of interested parties over another.

LO 4
SECOND LEVEL: FUNDAMENTAL CONCEPTS

Fundamental Quality—Faithful Representation

An information item that is free from error will be a more accurate

(faithful) representation of a financial item.

LO 4
SECOND LEVEL: FUNDAMENTAL CONCEPTS

Enhancing Qualities

Information that is measured and reported in a similar manner for

different companies is considered comparable.

LO 4
SECOND LEVEL: FUNDAMENTAL CONCEPTS

Enhancing Qualities

Verifiability occurs when independent measurers, using the same

methods, obtain similar results.

LO 4
SECOND LEVEL: FUNDAMENTAL CONCEPTS

Enhancing Qualities

Timeliness means having information available to decision-makers

before it loses its capacity to influence decisions.

LO 4
SECOND LEVEL: FUNDAMENTAL CONCEPTS

Enhancing Qualities

Understandability is the quality of information that lets reasonably

informed users see its significance.

LO 4
 Basic Elements

ILLUSTRATION 2-7
Conceptual Framework
for Financial Reporting

LO 5
 SECOND LEVEL: BASIC ELEMENTS
Elements of Financial Statements

Asset A resource controlled by the entity as a

result of past events and from which
future economic benefits are expected to
Liability flow to the entity.

Equity

Income

Expenses

LO 5
 SECOND LEVEL: BASIC ELEMENTS
Elements of Financial Statements

Asset
A present obligation of the entity arising
from past events, the settlement of which
Liability
is expected to result in an outflow from
the entity of resources embodying
Equity economic benefits.

Income

Expenses

LO 5
 SECOND LEVEL: BASIC ELEMENTS
Elements of Financial Statements

Asset

Liability

The residual interest in the assets of the

Equity
entity after deducting all its liabilities.

Income

Expenses

LO 5
 SECOND LEVEL: BASIC ELEMENTS
Elements of Financial Statements

Asset

Liability

Equity Increases in economic benefits during the

accounting period in the form of inflows or
enhancements of assets or decreases of
Income
liabilities that result in increases in equity,
other than those relating to contributions
Expenses from equity participants.

LO 5
 SECOND LEVEL: BASIC ELEMENTS
Elements of Financial Statements

Asset

Liability

Equity Decreases in economic benefits during the

accounting period in the form of outflows
Income or depletions of assets or incurrences of
liabilities that result in decreases in equity,
other than those relating to distributions
Expenses
to equity participants.
LO 5
 THIRD LEVEL: RECOGNITION, MEASUREMENT, AND
DISCLOSURE CONCEPTS

These concepts explain how companies should recognize,

measure, and report financial elements and events.

Recognition, Measurement, and Disclosure Concepts

ASSUMPTIONS PRINCIPLES CONSTRAINTS
1. Economic entity 1. Measurement 1. Cost
2. Going concern 2. Revenue recognition
3. Monetary unit 3. Expense recognition
4. Periodicity 4. Full disclosure
5. Accrual

ILLUSTRATION 2-7
Conceptual Framework for
Financial Reporting

LO 6
 THIRD LEVEL: ASSUMPTIONS

Basic Assumptions
Economic Entity – company keeps its activity separate from its
owners and other business unit.

Going Concern - company to last long enough to fulfill objectives

and commitments.
Monetary Unit - money is the common denominator.

Periodicity - company can divide its economic activities into time

periods.
Accrual Basis of Accounting – transactions are recorded in the
periods in which the events occur.

LO 6
 THIRD LEVEL: ASSUMPTIONS
BE2-8 Identify which basic assumption of accounting is best
described in each item below.
(a) The economic activities of FedEx Corporation
(USA) are divided into 12-month periods for the Periodicity
purpose of issuing annual reports.
(b) Total S.A. (FRA) does not adjust amounts in its Monetary
financial statements for the effects of inflation. Unit
(c) Barclays (GBR) reports current and non-current
classifications in its statement of financial Going Concern
position.
(d) The economic activities of Tokai Rubber
Industries (JPN) and its subsidiaries are merged Economic
for accounting and reporting purposes. Entity

LO 6
 THIRD LEVEL: BASIC PRINCIPLES

Measurement Principles
 Historical Cost is generally thought to be a faithful
representation of the amount paid for a given item.

 Fair value is defined as “the price that would be received to

sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement
date.”

 IASB has given companies the option to use fair value as the
basis for measurement of financial assets and financial
liabilities.

LO 7
 THIRD LEVEL: BASIC PRINCIPLES

Measurement Principles
IASB established a fair value hierarchy that provides insight into the
priority of valuation techniques to use to determine fair value.
ILLUSTRATION 2-4

LO 7
 THIRD LEVEL: BASIC PRINCIPLES

Revenue Recognition
When a company agrees to perform a service or sell a product to a
customer, it has a performance obligation.
Requires that companies recognize revenue in the accounting
period in which the performance obligation is satisfied.

LO 7
THIRD LEVEL:
BASIC
PRINCIPLES

Illustration: Assume the

Airbus (DEU) signs a
contract to sell airplanes
to British Airways (GRB)
for €100 million. To
determine when to
recognize revenue,
Airbus uses the five
steps for revenue
recognition shown at
right.

ILLUSTRATION 2-5
The Five Steps of
Revenue Recognition
 THIRD LEVEL: BASIC PRINCIPLES

Expense Recognition - Outflows or “using up” of assets or

incurring of liabilities during a period as a result of delivering or
producing goods and/or rendering services.
ILLUSTRATION 2-6
Expense Recognition

“Let the expense follow the revenues.”

LO 7
THIRD LEVEL: BASIC PRINCIPLES

Full Disclosure
Providing information that is of sufficient importance to
influence the judgment and decisions of an informed user.
Provided through:
 Financial Statements
 Notes to the Financial Statements
 Supplementary information

LO 7
THIRD LEVEL: BASIC PRINCIPLES

BE2-9 Identify which basic principle of accounting is best

described in each item below.
(a) Parmalat (ITA) reports revenue in its income Revenue
statement when it delivered goods instead of when Recognition
the cash is collected.
(b) Google (USA) recognizes depreciation expense for Expense
a machine over the 2-year period during which that Recognition
machine helps the company earn revenue.
(c) KC Corp. (USA) reports information about pending Full
lawsuits in the notes to its financial statements. Disclosure
(d) Fuji Film (JPN) reports land on its statement of
financial position at the amount paid to acquire it,
even though the estimated fair market value is Measurement
greater.
LO 7
THIRD LEVEL: COST CONSTRAINT

Cost Constraint
Companies must weigh the costs of providing the information
against the benefits that can be derived from using it.

 Rule-making bodies and governmental agencies use cost-

benefit analysis before making final their informational
requirements.
 In order to justify requiring a particular measurement or
disclosure, the benefits perceived to be derived from it
must exceed the costs perceived to be associated with it.

LO 8
THIRD LEVEL: COST CONSTRAINT

BE2-11 Determine whether you would classify these

transactions as material.

(a) In the current year, Blair Co. reduces its bad debt
expense to ensure another positive earnings Material
year. The impact of this adjustment is equal to
3% of net income.
(b) Damon Co. expenses all capital equipment under
€2,500 on the basis that it is immaterial. The Likely not
material
company has followed this practice for a number
of years.

LO 8
 GLOBAL ACCOUNTING INSIGHTS

Relevant Facts
Similarities
• The existing conceptual frameworks underlying U.S. GAAP and IFRS are very
similar. That is, they are organized in a similar manner (objective, elements,
qualitative characteristics, etc.). There is no real need to change many
aspects of the existing frameworks other than to converge different ways of
discussing essentially the same concepts.
• The converged framework should be a single document, unlike the two
conceptual frameworks that presently exist. It is unlikely that the basic
structure related to the concepts will change.
 GLOBAL ACCOUNTING INSIGHTS

Relevant Facts
Similarities
• Both the IASB and FASB have similar measurement principles, based on
historical cost and fair value. In 2011, the Boards issued a converged
standard on fair value measurement so that the definition of fair value,
measurement techniques, and disclosures are the same between U.S. GAAP
and IFRS when fair value is used in financial statements.

Differences
• Although both U.S. GAAP and IFRS are increasing the use of fair value to
report assets, at this point IFRS has adopted it more broadly. As examples,
under IFRS, companies can apply fair value to property, plant, and equipment;
natural resources; and, in some cases, intangible assets.
 GLOBAL ACCOUNTING INSIGHTS

Relevant Facts
Differences
• U.S. GAAP has a concept statement to guide estimation of fair values when
market-related data is not available (Statement of Financial Accounting
Concepts No. 7, “Using Cash Flow Information and Present Value in
Accounting”). The IASB has not issued a similar concept statement; it has
issued a fair value standard (IFRS 13) that is converged with U.S. GAAP.
• The monetary unit assumption is part of each framework. However, the unit
of measure will vary depending on the currency used in the country in which
the company is incorporated (e.g., Chinese yuan, Japanese yen, and British
pound).
 GLOBAL ACCOUNTING INSIGHTS

Relevant Facts
Differences
• The economic entity assumption is also part of each framework although
some cultural differences result in differences in its application. For example,
in Japan many companies have formed alliances that are so strong that they
act similar to related corporate divisions although they are not actually part
of the same company.
 GLOBAL ACCOUNTING INSIGHTS

About The Numbers

While the conceptual framework that underlies U.S. GAAP is very similar to that
used to develop IFRS, the elements identified and their definitions under U.S.
GAAP are different.
 Recognition and Measurement
Guidelines
• when and at what amount to record and report an element
• Recognition
• when to record and repot an item (e.g. asset, liability, revenue)
• an item should be recognized when
– it meets the definition of an element
– sufficient evidence for the existence of the item is availability
– the item can be measured in monetary terms with sufficient
reliability
•stages of recognition
– initial recognition – when recording the items in the books of
accounts
– subsequent remeasurement or revaluation – due to change as to
the value or usefulness of the item
– derecognition – removing an element from books of accounts
 Measurement
• At what amount to record and report an item
• the amount is usually expressed in monetary terms
• measurement basis or recording and reporting
methods include
– historical cost – initial amount of cash or cash equivalent
given up (e.g. all plant assets and inventory)
– current/replacement cost – the current cash or cash
equivalent needed to replace the item (e.g. inventory)
– current market value – cash or cash equivalent obtainable
by selling or needed to liquidate the item (e.g. short-term
investment)
– net realizable value – liquidating value of the item net of
other liquidating costs
– present value – the value today of the item (e.g. long-term
receivables
 Cash Flows and Income Measurement

– cash inflows versus revenues/gains

• collection of cash from investors (additional
investment), creditors (loans) or advance
payments by customers (unearned revenues)
are not revenues
– cash outflows versus expenses/losses
• cash payments for dividends, purchase of
assets (e.g. machinery) or cash loans to other
entities are not expenses
 Income measurement methods
– Three income measurement methods
• modified cash/accrual basis
• accrual basis
• cash basis
• Accrual basis
– revenues are recognized when earned and
realized regardless of when related cash is
received
– expenses are recognized when goods/services
are used/sold regardless of when related cash is
paid
 Income measurement methods
• Cash basis
 revenues are recognized only when collected
in cash
 expenses are recognized only when paid in
cash
 expenses exclude payments for dividends and
repayment of principals of loans
• Modified cash/accrual basis
Income measurement methods
Modified cash/accrual basis
– modified is a mixture of accrual and cash bases of accounting e.g. some
items may be recognized on accrual while other on cash basis
– when modified is applied to a merchandising business
• revenues from sales of inventory are recognized on accrual basis
• revenues from all other sources are recognized on cash basis e.g. rent
• cost of goods sold are recognized on accrual basis (or at the time of
sale)
• depreciation and amortization are recognized on accrual basis (based
on allocation of costs plant and intangible assets over their
respective useful lives)
• all other expenses are recognized on cash basis e.g. supplies and rent
– when modified is applied to a service giving enterprise
• revenues and accrued expenses are recognized on cash basis
• depreciation, amortization and prepaid items are recognized on
accrual basis
 Converting cash-basis financial
statements to accrual-basis
Cash basis Accrual basis
Adjustments
+ accounts receivable-ending
cash collection from customers = sales revenue
- accounts receivable-beginning

+ unearned rent-beginning
cash collection from other income - unearned rent-ending
= rent income
(e.g. rent)
+ rent receivable-ending
- rent receivable-beginning

+ accounts payable-ending
cash payments to inventory - accounts payable-beginning
= cost of goods sold
suppliers
+ inventory-beginning
- inventory-ending

+ prepaid items-beginning
cash payments for operating - prepaid items-ending
= rent/salary/supplies expenses
expenses (e.g. supplies, rent, salary)
- accrued items-beginning
+ accrued items-ending

cash payments for tangible and

Depreciation/amortization
intangible long-term operational C, EL, Method and SV =
expenses
assets (e.g. buildings and franchise)
 CASH-BASIS ACCOUNTING VERSUS ACCRUAL-
BASIS ACCOUNTING

Illustration: Quality Contractor signs an agreement to construct a

garage for ₺22,000. In January, Quality begins construction, incurs
costs of ₺18,000 on credit, and by the end of January delivers a finished
garage to the buyer. In February, Quality collects ₺22,000 cash from
the customer. In March, Quality pays the ₺18,000 due the creditors.
 CASH-BASIS ACCOUNTING VERSUS ACCRUAL-
BASIS ACCOUNTING

Illustration: Quality Contractor signs an agreement to construct a

garage for ₺22,000. In January, Quality begins construction, incurs
costs of ₺18,000 on credit, and by the end of January delivers a finished
garage to the buyer. In February, Quality collects ₺22,000 cash from
the customer. In March, Quality pays the ₺18,000 due the creditors.
 CASH-BASIS ACCOUNTING VERSUS ACCRUAL-
BASIS ACCOUNTING

CONVERSION FROM CASH TO ACCRUAL BASIS

Illustration: Dr. Diane Windsor, like many small business owners, keeps
her accounting records on a cash basis. In the year 2015, Dr. Windsor
received ₺300,000 from her patients and paid ₺170,000 for operating
expenses, resulting in an excess of cash receipts over disbursements of
₺130,000 (₺300,000 - ₺170,000). At January 1 and December 31, 2015,
she has accounts receivable, unearned service revenue, accrued
liabilities, and prepaid expenses as shown below.
 SERVICE REVENUE COMPUTATION

To convert the amount of cash received from patients to service

revenue on an accrual basis, we must consider changes in accounts
receivable and unearned service revenue during the year.
 OPERATING EXPENSE COMPUTATION

To convert cash paid for operating expenses during the year to

operating expenses on an accrual basis, we must consider changes in
prepaid expenses and accrued liabilities.
CONVERSION FROM CASH BASIS TO ACCRUAL
BASIS