Accounting concepts & conventions 2

Accounting concepts & conventions 2

by Thu Nga

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​Matching principle

​Revenue should match with expenses such as:

• Incurred to earn the revenue

• Include those incurred in the current or previous periods or accruals which associated with the revenue of the current period

​Example

​•A hospital pays $20,000 per month to 5 of its doctors. Monthly sales are $500,000.

=>$100,000 worth of monthly salaries should be matched with $500,000 of revenue generated.

​Example

​In a business contract between company A and company B:

• On 25/12/N, A sent goods to B. The cost of goods was $250m.

•On 5/1/N+1, the customer declared that they has received the goods and accepted paying in 5 days. The selling price was $300m.

​•Expense = $250m 

•Revenue =  $300m

•Matching principle requires A did NOT recognize the COGS for year N. They would recognize COGS (at $250m) and relating revenue (at  $300m) for the year N+1.

​Materiality concept

Information is material if its omission or misstatement could influence the economic decision of the users.

•Materiality depends on the size of items or errors judged in certain circumstance.

•It is considered in both qualitative and quantitative terms.​

​Materiality concept - Example

​Company A bought 10 computers to use in its office at cost of $10m. The expected using life of the computer was 4 years.

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​Example

Considered as material matter:

• The cost would be allocated and recognized in Expense for 4 years​

• (Each year: $2.5m).

​• Considered as immaterial matter:

All the cost would be recognized in Expense for 1 years

​(All in year N: $10m).

​Materiality concept - Revision:

​Materiality depends on the size of items or errors judged in certain circumstance

•Usually the assessment is a subjective exercise. (decided by professionals)

•Not only the value but also the context should be considered.

​Example:

​•A company has a building which is destroyed and after a lengthy battle with the insurance company, it reports an extra ordinary loss of $10,000

•What happens if...?

Multiple Choice

........It's a large company with net income of $10,000,000?

• this loss is immaterial

• this loss is material

Multiple Choice

..........The company is a smaller one with only $50,000 of net income

• this loss is immaterial

• this loss is material

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​Definition

​•In accounting, a business or an organization and its owners are treated as two separately identifiable parties. This is called the entity concept.

​Consequence:

​•This helps to give a correct determination of the true financial conditions of the business.

​Example

​•Clothing is a personal expense and can't be recorded in the company financial statements.

•Instead, these transactions should be accounted for as an owner withdrawal.

​Example:

​•A CPA has 3 rooms in a house he has rented for $3,000 per month. He has setup a single-member accounting practice and uses one room for the purpose.

•How should the rental expense be recorded?

Multiple Choice

How should the rental expense be recorded?

•  $1,000 should be charged to business

• $2,000 should be charged to business

• $3,000 should be charged to business

​Money measure concept

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​Definition

​•Only transactions and events that are capable of being measured in monetary terms are recorded.

•Transactions which cannot be expressed in terms of money or non-quantifiable items can not be recorded.

​Examples of some items that can not be recorded:

​•Employee skills

•Employee working conditions

•Value of an in-house brand

•Product durability

•The quality of customer support or field service