6.1 pps t/a carnegie et al; accounting: financial and organisational decision making © 1999...
TRANSCRIPT
6.
1
PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.
ACCOUNTINGACCOUNTINGFinancial and Organisational Financial and Organisational
Decision MakingDecision Making
Chapter 6
Underlying assumptions of the historical cost accounting system
Slides written and designed by
Tony Van Eekelen
6.2
Chapter 6: Underlying assumptions of the historical cost accounting system
PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.
Learning ObjectivesLearning Objectives
• In this chapter you will be introduced to – how a general theoretical framework can help
with choosing between alternatives
– a theoretical framework in terms of objectives, assumptions, principles and rules
– the difference between an inductively and deductively derived framework
6.3
Chapter 6: Underlying assumptions of the historical cost accounting system
PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.
Learning ObjectivesLearning Objectives– how the objectives,
assumptions and principles impact on the recording and reporting of accounting information
– how the assumptions relate to the objectives of historical cost accounting
– the elements of historical cost accounting reports
6.4
Chapter 6: Underlying assumptions of the historical cost accounting system
PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.
The problem of choiceThe problem of choice
• Should the event be included in the accounting system?
• How will the accounting equation be affected by this event?
• These two choices exist throughout accounting and thus it is necessary to establish some principles to guide the process of decision making.
6.5
Chapter 6: Underlying assumptions of the historical cost accounting system
PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.
A general framework for designA general framework for design
Objectives
Assumptions
Principles
Rules
6.6
Chapter 6: Underlying assumptions of the historical cost accounting system
PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.
A general framework to aid decision A general framework to aid decision makingmaking
• Objectives– set the purpose for why we are making the
decisions
• Assumptions– are statements accepted by the designer as self-
evident facts without argument– are varied by degree of certainty– regard all assumptions with caution
6.7
Chapter 6: Underlying assumptions of the historical cost accounting system
PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.
General frameworkGeneral framework
• Principles– must be justified entirely by logical argument
within the framework
• Rules– application of principles – are more specific and narrower than principles
6.8
Chapter 6: Underlying assumptions of the historical cost accounting system
PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.
Deductive vs. InductiveDeductive vs. Inductive
• The above model of objectives, assumptions, principles and rules can be derived in two ways.
• The deductive approach is to start with the objectives and work your way down.
• Thus the rules and principles are deduced from the objectives and assumptions
6.9
Chapter 6: Underlying assumptions of the historical cost accounting system
PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.
Deductive vs. InductiveDeductive vs. Inductive
• An alternative approach is to look at what system already exists
• This method of inductive research involves observing the current practice and inducing the principle and objectives
• Historical cost accounting developed this way
6.10
Chapter 6: Underlying assumptions of the historical cost accounting system
PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.
Deductive vs. InductiveDeductive vs. Inductive
Objectives Assumption Principles Rules
Empirical inductive approach
Deductive approach
6.11
Chapter 6: Underlying assumptions of the historical cost accounting system
PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.
The objectives of historical cost The objectives of historical cost accounting systemaccounting system
• The objective of an accounting system involves the production of relevant and reliable information to aid the users of this information in their decision making process.
• Problem: trade-off between reliability and relevance
6.12
Chapter 6: Underlying assumptions of the historical cost accounting system
PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.
The assumptions of the historical cost The assumptions of the historical cost accounting systemaccounting system
• Assumptions have been derived to achieve the objective of reliability and relevance
ObjectivesUsefulness of information for decision making
requiring
Relevance Reliability
6.13
Chapter 6: Underlying assumptions of the historical cost accounting system
PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.
Relevance assumptionsRelevance assumptions
• Accounting entity– Separation
• distinguishes between the affairs of the owners and the entity
• in smaller firms (sole traders and partnerships) the separation is more difficult as by law the two accounting entities are one. Not so for companies.
– Viewpoint• procedures relate to the entity• owner is an external party
6.14
Chapter 6: Underlying assumptions of the historical cost accounting system
PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.
Relevance assumptionsRelevance assumptions
• Ownership and economic resources– Accountants have the task of measuring only
those resources that have economic value– Two types of value
• value in exchange• value in use
– resources must be scarce• economic resources = creditors’ claims + owners’
claims
6.15
Chapter 6: Underlying assumptions of the historical cost accounting system
PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.
Relevance assumptionsRelevance assumptions
• Money measurement– the unit of measurement is important– money as a medium of exchange is assumed to
be the unit of measurement– use national currency $– Problems
• inflation• exchange rates• time value of money
6.16
Chapter 6: Underlying assumptions of the historical cost accounting system
PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.
Relevance assumptionsRelevance assumptions
• Accounting period– requirement for information at regular intervals– problems
• ‘cut-off’ date may result in incomplete venture
• thus measurement problem
• valuing of inventory, value of asset
6.17
Chapter 6: Underlying assumptions of the historical cost accounting system
PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.
Relevance assumptionsRelevance assumptions
• Continuity or going concern– the entity is assumed to continue in operation
into the foreseeable future– at end of accounting period this assumption of
continuity assumes that incomplete ventures will be completed in the future
– assets are placed in the balance sheet to show the future economic benefit
6.18
Chapter 6: Underlying assumptions of the historical cost accounting system
PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.
Relevance assumptionsRelevance assumptions• Capital maintenance and profit
– no dividends can be paid except out of profits
– profits are defined as the growth in net assets over a period of time after owners’ contributions are taken into account
$100,000Capital
$100,000
Increase $20,000
Net assets beginning
Net assets end
6.19
Chapter 6: Underlying assumptions of the historical cost accounting system
PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.
Reliability assumptionsReliability assumptions
For information to be reliable it must not contain bias or errors
• Faithful representation– financial statements faithfully represent all the
transactions and events in the accounting period– historical cost system does this well
6.20
Chapter 6: Underlying assumptions of the historical cost accounting system
PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.
• Verifiability
– similar measures or conclusions would be reached if two or more qualified persons examined the same data
– again historical cost performs this well
Reliability assumptionsReliability assumptions
6.21
Chapter 6: Underlying assumptions of the historical cost accounting system
PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.
The broad principle of historical cost accountingThe broad principle of historical cost accounting
• Using the objectives of reliability and relevance and the assumptions, principles can now be derived
• Two main principles are
– primary transaction basis
– dollar measurement
6.22
Chapter 6: Underlying assumptions of the historical cost accounting system
PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.
Primary transactions basisPrimary transactions basis
• No primary entry may be entered into the accounting system unless it is evidenced by a past external transaction involving the entity
• external event involving the transfer of something of value between two entities
• evidence includes all documents• secondary entries do exist
– essentially reallocation of amounts from primary entries
6.23
Chapter 6: Underlying assumptions of the historical cost accounting system
PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.
Events vs. transactionsEvents vs. transactions
External transactions
All economic eventsaffecting entity
Data processing
Reports onentity
6.24
Chapter 6: Underlying assumptions of the historical cost accounting system
PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.
Dollar measurementDollar measurement
• Every transaction or event recorded in the accounts shall be measured in dollars
• Follows from the money measurement assumption
6.25
Chapter 6: Underlying assumptions of the historical cost accounting system
PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.
Statement elementsStatement elements
• Assets– are economic resources controlled by the entity for the
purpose of providing future benefits to that entity
– Related assumptions are• resources offering future benefits through use or exchange -
ownership & economic resources
• under the control of the entity - entity, ownership and economic resources
• It must have been acquired in a past, external transaction - primary transaction principle
6.26
Chapter 6: Underlying assumptions of the historical cost accounting system
PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.
Statement elementsStatement elements
• Liabilities– regarded as an obligation and meets the
following• A claim on the entity involving a future sacrifice of
economic resources - ownership and economic resources
• the resources are to be sacrificed by the entity to an external entity - entity assumption
• Must arise out of a past external transaction - primary transactions principle
6.27
Chapter 6: Underlying assumptions of the historical cost accounting system
PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.
Statement elementsStatement elements
• Owners’ equity– Interest of owners in the net asset of an entity at
any time– Owners’ equity = assets - liabilities– Capital
• changes due to contributions or withdrawals not profits
– Profits• is the change in net assets after capital changes
6.28
Chapter 6: Underlying assumptions of the historical cost accounting system
PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.
Statement elementsStatement elements
• Revenue– are accomplishments of the earning process of a
business enterprise during a period– usually represent cash inflows that have
occurred or will probably eventuate– will be as a result of the entity’s operations
during the period– Capital contributions are not revenue
6.29
Chapter 6: Underlying assumptions of the historical cost accounting system
PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust.
Statement elementsStatement elements• Expenses
– maybe regarded as expired assets– as economic resources that have been consumed during
the period• resources consumed must have been acquired in a past
transaction - primary transaction basis• resources that have expired during the period - ownership and
economic resources• Withdrawals by owners are not expenses but capital reduction
- capital maintenance
– Problem - when a resource has been consumed and how much has been consumed?