1.8 Recognition and Measurement Concepts Flashcards
Define recognition
is the formal recording or incorporation of an item in the financial statements as an asset, liability, revenue, expense, gain, loss, etc.
What is the recognition criteria designed to determine?
determine whether and when items are incorporated into the financial statements, either initially or as changes in existing items
Identify the 4 fundamental recognition criteria:
HINT: Recognition Defines Measurable Relevance and Reliability
- The item must meet the definition of an element of financial statements
- It must have a relevant attribute MEASURABLE with sufficient reliability
- The information must be RELEVANT. It must be capable of making a difference in user decisions.
- The information must be RELIABLE. It must be representationally faithful, verifiable, and neutral.
Identify the constraint and threshold all items are subject to before being incorporated into the financial statements
- pervasive cost constraint
- materiality threshold
When are revenues and gains recognized according to the revenue recognition principle? (2)
- when realized or realizable
- when earned
How are revenues and gains measured according to the revenue recognition principle?
by the exchange prices of the assets or liabilities involved
When are revenues and gains REALIZED according to the revenue recognition principle?
when goods or services have been exchanged for cash or claims to cash
When are revenues and gains REALIZABLE according to the revenue recognition principle?
when goods or services have been exchanged for assets that are readily convertible into cash or claims to cash
Identify 2 elements that readily convertible assets must have:
- Interchangeable (fungible) units and
- Quoted prices available in an active market that can rapidly absorb the quantity held by the entity without a significant effect on the price
When are revenues considered EARNED according to the revenue recognition principle? (2)
- when the earning process has been substantially completed
- and the entity is entitled to the resulting benefits or revenues
Are expenses subject to the realization criterion? Explain
No - because of the conservatism constraint
When are expenses and losses recognized according to expense recognition criteria? (2)
- a consumption of economic benefits occurs or
- the ability of existing assets to provide future benefits is impaired
Provide an example of an expense or loss being recognized when a liability has been incurred or increased without the receipt of corresponding benefits
A probable and reasonably estimable contingent loss
Identify the 3 expense recognition principles:
- associating cause and effect (aka matching)
- systematic and rational allocation
- immediate recognition
Define “associating cause and effect aka matching”
the simultaneous recognition of revenues and expenses that directly result from the same transactions or other events.
Provide 2 examples of matching or associating cause and effect as an expense recognition principle
- sales revenue and the related cost of goods sold, shipping expenses, and selling expenses
- estimated bad debt expense and the related credit sales
Define “immediate recognition” as an expense recognition principle
- applies when costs cannot be directly or feasibly related to specific revenues
- benefits of costs are used up in the period in which they are incurred
- periods to which they relate may not be feasibly determinable
Provide examples of costs that are immediately recognized (4)
- R&D costs
- write-offs of worthless assets
- utilities expense
- employees’ monthly salaries
Identify the 5 measurement attributes
HINT: HCCNP
- historical cost
- current (replacement) cost
- current market value (exit value)
- net realizable value (NRV)
- present value
What might current or replacement cost be used for? (2)
- to measure LIFO and retail method inventories
Define current (replacement) cost
the amount of cash that would have to be paid for a current acquisition of the same or an equivalent asset
Define current market value (exit value)
cash or equivalent realizable by selling an asset in an orderly liquidation (not in a forced sale)
When is the current market value (exit value) used?
used to measure some marketable securities, e.g., those held by investment entities or assets expected to be sold at below their carrying amount (lower of cost or market)
Define net realizable value or NRV
the cash or equivalent expected to be received for an asset in the due course of business, minus the costs of completion and sale
When is net realizable value or NRV normally used?
to measure short-term receivables and some inventories.
What is net settlement value?
- the relevant attribute for trade payables and warranty liabilities
- the sum of the undiscounted amount of cash (or equivalent) expected to be paid to liquidate an obligation in the ordinary course of business
Define present value
- in theory the most relevant method of measurement because it incorporates time value of money concepts
How is present value or PV calculated?
- choose an appropriate discount rate or interest rate
- identify the timing and amount of future cash flows
What is PV currently mainly used for in relation to measurement attributes?
non-current receivables and payables
