BASIC ACCOUNTING PRINCIPLES

Measurement

Revenue recognition

Expense recognition

Full disclosure
 Basic Accounting Principles

Basic Accounting principles are used to

record and report transactions.
Four basic principles of accounting

o Measurement
o Revenue recognition
o Expense recognition
o Full disclosure
1. Measurement Principle
Measurement is the process of assigning a value to the
transaction or item.

Which means only transactions and events that are

capable of being measured in monetary terms are
recognized in the financial statements.
 Measurement Principle (contd..)

So, what happens to transactions or events that cannot be

measured in monetary terms ?

Material transactions or events failing to meet

measurability criteria might need to be disclosed in the
supplementary notes to financial statements.
Measurement Principle (contd..)

Assign a value to transaction or event

using some measurement base

 Measurement Principle (contd..)

Most common measurement bases are;

Historical cost

Fair value
 Historical cost Fair value
 Historical cost of an asset is  Fair value is market based.
its acquisition cost.
 It is a price that would be
 Many assets and liabilities received to sell an asset or
are recorded on the basis of paid to transfer a liability in
their historical cost. an orderly transaction
between market participants
 Historical cost is verifiable at the measurement date.
however, it may not
provide a good
representation of an asset’s
or liability’s current cash
value.
 Measurement Principle (contd..)
FAIR VALUE

 GAAP has increasingly recommended the use of fair value to measure items in
financial statements, particularly financial instruments.

 Fair value provide better information than historical cost about co.’s financial
position.

 Fair value is a better basis for assessing co.’s future cash flow.

 However, fair value estimates can be subjective. If, for instance an active market
does not exist for an asset or a liability.
 Measurement Principle (contd..)

LEVEL 1 is considered as most accurate

The FASB has
established a
If level 1 method is not available then level 2 method should be
“Fair value used.
hierarchy” with
three levels.
Level 3 method is used only if level 1 & 2 methods are not
available.
  Level 1: Quoted price in active market, such as closing stock.
LEVEL 1
[Fair value
hierarchy]
 2
Level : Inputs other than Quoted price,
that are observable for asset or liability.
LEVEL 2
[Fair value Which includes;
o Quoted price of similar assets or liabilities in active market.
o Quoted price of identical assets or liabilities in market that are

hierarchy]
not active.
o Market corroborated inputs (Inputs that are derived principally
from or corroborated by observable market data by correlation or
other means.
 Level 3: Unobservable inputs, such as co.’s
own data and inputs.
LEVEL 3
[Fair value Level 3 estimates are subjective and much judgements is
needed to arrive at the fair value measurements.

hierarchy] Value may be developed using expected cash flow or present

value techniques.
2. Revenue recognition principle
The revenue recognition principle requires that the co.’s recognizes revenue
in the accounting period in which their performance obligation is met.

Revenues be shown in the income statement in the period in which they

are earned, not in the period in which cash is collected.

When a transaction is begun and completed in the same period, this

requirement poses no problem. However, in some situation the exact
moment to recognize revenue could be a problem.
Revenue recognition principle (contd..)

Revenue may also be recognized under the following methods in

the right circumstances;

o Percentage of completion method for long term contracts,

o Production basis for agriculture and precious metals,
o Instalment basis when collectability of account is not certain,
o Cost-recovery basis when recognition of gross profit is deferred until all
cost of sales is recovered.
3. Expense recognition principle
Expense should be matched with revenue. Recognition of expense should
match with recognition of revenue.

Expense should be recognized not when payment is made but when the work
for which payment is made contributes to revenue.

Some cost are charged to current period as expense because no direct

connection can be made with revenue. Example: Administrative expense,
senior management salaries, etc.

Cost that can be connected to revenue are called product cost whereas the
cost that cannot be connected to revenue are called period cost.
 4. Full disclosure principle
Full disclosure principle states that companies
should provide information that is of “sufficient
importance to influence the judgements and
decisions of an informed user”.
Full disclosure principle (contd..)

The information about financial position, income, cash flow and investments
are available in one of the three places;

o The main body of financial statements: To be presented in the main

body the item should be a basic element of financial statement, be
measurable with certainty and be relevant and reliable.
o Notes to financial statements: Notes are used to amplify the
information presented in the main body.
o Supplementary schedule: Include management’s explanation of the
financial information presented and a discussion of its significance.