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01 Generally Accepted
Accounting Principles
Accounting Constraints,
Concepts, Assumptions,
and Principles
GAAP PowerPoint #3
Hierarchy of Qualitative
Information
Comparability
and Consistency
Decision Usefulness
Discussed
in PPT #2
Cost/Benefit
Materiality
www.fasb.org
Constraints
A constraint is a limit, regulation, or
confinement within prescribed bounds.
This term refers to the accounting
guidelines that border the Hierarchy of
Qualitative Information
They consist of:
Cost Effectiveness
Materiality
Conservatism
Cost Effectiveness
Constraint
Also called Cost Benefit Constraint
The cost of providing accounting
information should not exceed the benefit of
the information it is reporting.
Example: Your checkbook register and
bank statement differs by $0.10. Rather
than waste time to find the $0.10, the
accountant should record the amount as
miscellaneous expense or income.
Materiality Constraint
Conservatism Constraint
Concepts
Concepts are the ground rules of
accounting that should be followed when
preparing financial statements.
These are:
Recognition Concept
Measurement Concept
Recognition Concept
Measurement Concept
States that every transaction is measured
by the stated unit of measurement, such as
the dollar
The stated procedure of valuing assets,
liabilities, equity, revenue, and expenses as
defined by GAAP
Assumptions
Assumptions are agreed upon rules of
accounting, and are basic, understood
beliefs.
There are Four Basic Assumptions of
Accounting:
Principles of Accounting
Principles are accounting rules used to
prepare, present, and report financial
statements.
Principles dictate how events should be
recorded and reported.
Cost Principle
Assets are recorded at historical cost, not
fair market value.
For example, if a company purchases a
building for $500,000 it should be recorded
as such, and should remain on the books for
that amount until disposed of.
If the building appreciates to $700,000 in
the next few years, no adjustment should
be made.
Revenue Recognition
Principle
Revenue is earned and recognized upon
product delivery or service completion,
without regard to when cash is actually
received.
Also called accrual basis accounting
Example: A customer purchases inventory
from a company on credit. Even though no
cash has yet been received, the sale is
recorded.
Matching Principle
The costs of doing business are recorded in
the same period as the revenue they help
generate, regardless of when the money is
actually paid.
Also called accrual basis accounting
Example: A company orders merchandise
on credit and has 30 days in which to pay.
This purchase is recorded immediately,
even though no cash has been paid.
Chapter 1
Getting Started:
Principles of
Finance
1.1 FINANCE:
AN OVERVIEW
What is Finance?
Finance is the study of how people and
businesses evaluate investments and raise
capital to fund them.
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FINC-301, Chapter 1,
Russel
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Sole Proprietorship
It is a business owned by a single individual
that is entitled to all the firms profits and is
responsible for all the firms debt.
There is no separation between the business
and the owner when it comes to debts or
being sued.
Sole proprietorships are generally financed by
personal loans from family and friends and
business loans from banks.
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Easy to start
No need to consult others while making decisions
Taxed at the personal tax rate
Disadvantages:
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Partnership
A general partnership is an association
of two or more persons who come together
as co-owners for the purpose of operating
a business for profit.
There is no separation between the
partnership and the owners with respect to
debts or being sued.
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Partnership (cont.)
Advantages:
Relatively easy to start
Taxed at the personal tax rate
Access to funds from multiple sources or partners
Disadvantages:
Partners jointly share unlimited liability
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Partnership (cont.)
In limited partnerships, there are two
classes of partners: general and limited.
The general partners runs the business
and face unlimited liability for the firms
debts, while the limited partners are
only liable on the amount invested.
One of the drawback of this form is that
it is difficult to transfer the ownership of
the general partner.
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Corporation
Corporation is an artificial being, invisible,
intangible, and existing only in the
contemplation of the law.
Corporation can individually sue and be
sued, purchase, sell or own property, and
its personnel are subject to criminal
punishment for crimes committed in the
name of the corporation.
Copyright 2011 Pearson Prentice Hall. All rights reserved.
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Corporation (cont.)
Corporation is legally owned by its current
stockholders.
The Board of directors are elected by the
firms shareholders. One responsibility of
the board of directors is to appoint the
senior management of the firm.
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Corporation (cont.)
Advantages
Disadvantages
Greater regulation
Double taxation of dividends
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Hybrid Organizations
These organizational forms provide a cross
between a partnership and a corporation.
Limited liability company (LLC)
combines the tax benefits of a partnership
(no double taxation of earnings) and
limited liability benefit of corporation (the
owners liability is limited to what they
invest).
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Corporate Mission
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Corporate Mission
While managers have to cater to all the
stakeholders (such as consumers, employees,
suppliers etc.), they need to pay particular
attention to the owners of the corporation i.e.
shareholders.
If managers fail to pursue shareholder wealth
maximization, they will lose the support of
investors and lenders. The business may cease to
exist and ultimately, the managers will lose their
jobs!
Copyright 2011 Pearson Prentice Hall. All rights reserved.
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Ethics in Finance
What do we mean by Ethics?
Give examples of recent financial scandals
and discuss what went wrong from an
ethical perspective.
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2.
3.
Monitoring
(Examples: Reports, Meetings, Auditors, board of
directors, financial markets, bankers, credit agencies)
Compensation plans
(Examples: Performance based bonus, salary, stock
options, benefits)
Others
(Examples: Threat of being fired, Threat of takeovers,
Stock market, regulations such as SOX)
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