Accounting period, assumption, basic methods and terms

Accounting period:
Annual (fiscal) or quarterly and others as defined. Should be uniform to allow comparison across time.

Assumptions for accounting statement

• Going-concern - the company will continue to operate.
• Revenues-recognition principle - revenues are reported as they are earned within the specified accounting period
• Matching principle - report expenses and revenue in same period

Basic accounting methods
Cash-basis accounting

• Recognize revenue (income) and expenses when payments are made (checks issued) or cash is received (deposited in the bank).

Advantages

• easy to use and implement
• Few transactions (bookkeeping) recorded on average
• Tax when it has money in the bank

Disadvantages

• Distort actual income and expenses

Accrual accounting

• Recognize revenue in the accounting period in which it is earned (when a product or service is provided to a customer, regardless of when the company gets paid). Expenses are recorded when they are incurred instead of when they are paid

Advantages:

• More accurate measurement
• Economic effect of revenue & expenses
• enhance comparability of income statement across periods
• A smoother earning stream
• enhanced predictability of future cash flow

Tips:

• In the exam, assume all financial statements use accrual-basis accounting unless specified otherwise.

Accounting term
Debit

• Refer to an entry that increases an expense or asset account, or decreases an income, liability or net-worth account.

Credit

• Refer to an entry that decreases an expense or asset account, or increases an income, liability or net-worth account.

Objectives of financial reporting identified in SFAC 1 are to do the following:

• Useful information to investors and creditors for their decision making
• Allow comparability
• Provide relevant (timeliness) information - the capacity to alter decision
• Provide reliable information

Notes:

• market value is relevant but not reliable; Historic data is reliable but not relevant;
• Equity investor concern long term earning power and dividend; Short term investor concern liquidity;
• Long term creditors concern long term asset position and earning power.