xxx Flashcards
What are the eight principles of GAAP?
- Entity principle
- Cost principle: money as a measure
- The going concern principle
- The conservatism and cost principle
- The matching principle
- The consistency principle
- The materiality principle
- The accrual principle
What is GAAP?
GAAP is the generally accepted accounting principle.
GAAP is a set of principles that guide the government and the non-profit sector in Canada on how financial information will be created, reported, audited, and generally understood.
What is the entity principle?
This principle defines the unit or entity being reported. You have to be able to determine what is in and what is out of the unit for which you are preparing reports. The users have to know what these reports refer to and exclude anything that is not related to that entity.
What is the cost principle: money as measure?
All information in the financial statement must be monetized. Accounting recognizes only those activities that can be expressed in monetary terms. This principle pulls together hetergenous information in terms of costs.
The monetization or cost principle permits an organization to develop an understanding of the value of its assets (in terms of costs). The tool most commonly used in placing monetized value on asset is the historic cost (recording what was paid for the asset orginally)
This principle reflects the conservatism principle
What is the going concern principle?
This principle states that the organization will continue to operate for the foreseeable future in the absence of evidence to the contrary.
Assets are treated according to what is expected to happen over the normal course of operations and over their anticipated useful lifetime. They will be expected to depreciate in value or to be amortized.
The heart of this principle remains that only what is known can be used in financial statements and unless some information is available that indicates otherwise, the organization will carry on
What is the conservatism and cost principle
This principle requires that accountants value assets at the lower of their historical cost or market value
This has been described as a principle by which accountants recognize no gains until they happen, but record all possible losses even before they take place
When in doubt, it is better to overstate expense and understate revenue
What is the matching principle?
The matching principle states that all expenses must be recorded in the same accounting period as the revenue that they helped to generate
The matching principle normally refers to the matching of revenue and expenses
for government entities: revenues should be recognized when the goods and/or services have been rendered and expenses should be matched to program delivery outputs of services to the public
What is the consistency principle?
This principle holds that, once an organization has adopted a set of standards for accounting and financial reporting it will continue to use them, so as to allow for consistent comparisons between time periods
When they change them, they have to provide what is a called a “cross walk” to explain where changes have been made in the financial information in order to permit comparisons
What is the materiality principle?
Whether the information being reported is significant to users of financial statements in making decisions or arriving at an understanding of the organization’s financial position
What is the accrual principle?
The elements of the accrual basis that are significant to this principle are that:
- revenue is recognized when goods and services are provided, even if payment has not occurred
- expenses are recorded on consumption of the assets
- a full set of financial statements are used to support the accrual basis
Accrual is seen as providing a much more complete picture of the financial condition of an organization
Key differences between cash and accrual accounting
Cash Accounting
- Does not record the impacts of assets and liabilities
- money borrowed with a long-term liability is considered as a cash inflow and it not stated in the financial statements until it is due and payable
- Recognition and transparency are diminished
Accrual accounting
- Recognizes events and transactions when they occur by recording accounts payable and receivable and the changes in the values of the assets and liabilities
- It keeps a tally of what the organization own and owes, it also depletes the values of those assets as it uses them up
- Liabilities and expenses are recorded when the event occurred. The cash is paid, the liability is removed
- Upon receipt of goods this system provides two information: creation of liability or obligation to pay and information about the level of inventory (asset)
Name and describe two advantages of accrual accounting
- little to no cash manipulation of cash
2. records assets including depreciation and replacement
Name and describe two disadvanatages of accrual accounting
- Standards are open to manipulation
distortions of the accrual system through manipulation in 2 ways:
-revenue is recognized on the basis of flimsy evidence (record sale as income even though it was only an agreement)
-the write-off of bad debts or deferral of the timing of certain cost flows is manipulated to make the organization’s performance look better in a specified period - Poor linkage to budget information when the budgets are on cash basis making financial reports difficult to understand and create the need for “cross-over” reports
Name two objectives that a budget accomplishes
A budget translates policy intention into specific activities through the allocation of resources to that goal or to one or more objectives
A budget sets limits on expenditures to guide managers within the organization
What is budgeting in the public sector?
For government, a budget is necessary to allocate resources and get the authority to spend
The public sector working within an approved budget is a distinct measure of sound management. This works in two ways:
-managers faces criticism for overspending and underspending
What is budgeting in the private sector?
A budget is a flexible set of planning parameters that can change as market conditions change and input cost variation
The bottom line of accountability lies with profitability, share value, and the economic sustainability of the firm. Compliance with a budget is more of a short term internal control, subject to fairly rapid fluctuations
Define capital budgeting?
Contain the plans and resource allocations for capital acquisitions to support the program of the organizations
Capital budgets involve multi-year expenditure projections with approval for the current-year expenditures
Capital budget focuses on non-recurring goods
Buildings are built on a one-time basis, and the capital budget would not automatically contain a plan for another building once one was built
Capital budget: capital expenditure refers to any significant expenditure to acquire or improve land, buildings, engineering structures, machinery equipment and related services used in providing municipal services. Those normally confer benefits lasting beyond one year
Land and buildings are well-known capital goods and information technology infrastructure is part of the capital budgets
• Determining is in and what is not treated as a capital item is a matter of policy within public-sector organization
Explain two characteristics of capital assets
Characteristics of capital assets
- Productivity criterion: they are used in production and supply of goods and services
- Exclusive use criterion: they are not intended for resale in the ordinary course of operations
They are recorded as non-financial assets along with other such assets as prepaid expenses and inventories held for future use
Why has Ontario steered towards alternate financing procurement (AFP) as a model for capital projects look at risks and costs (from the book)
Governments are looking for ways to finance expensive capital projects without the use of appropriated funds, or at least minimizing their use or spreading the high impact of capital funding over the many years
E.g. YORK region subway. Steven Del Duca
E.g. bidding to for snow plows removers
Website definition of AFP
Alternative Financing and Procurement (AFP) is a made in Ontario approach to financing and procuring large, complex public infrastructure projects. It leverages partnerships with the private sector to expand, modernize and replace Ontario’s aging infrastructure.
Under AFP, provincial ministries and/or project owners establish the scope and purpose of a project, while design and construction work is financed and carried out by the private sector. Typically, only after a project is completed will the province complete payment to the private-sector company. In some cases, the private sector will also be responsible for the maintenance of a physical building or roadway.
The AFP model allows projects to be delivered more efficiently and more cost effectively than traditional procurement. AFP also protects taxpayers from cost overruns by transferring project risks to the party with the expertise, experience and ability to handle that risk best.
Alternative financing schemes for the government (not as important)
Traditional: governments create the capital asset, finance it through appropriations or special borrowing (bonds) and operate the asset
Commercialization: government create the capital asset above but operates autonomously or is operated, through a contract, by the private-sector
Public Private partnership (PPPs): governments enter into complex arrangements for shared or private financing, building and operation of a facility that remains in the public realm and often reverts to public-sector ownership at the end of the pay-back period
Privatization: governments cease carrying out an activity. Taken up by the private sector or actioned by a part of government that has been privatized, all capital and operating spending is undertaken by the company with no direct government involved. This does not exclude government creating regulations or rules to govern these enterprises
Describe two examples of risks that can affect capital planning projects
General Risks–examples include high-level concerns related to the decision to undertake an initiative. risk treatment may include documenting how an initiative fits with establishes strategic objectives; assessing the requirements for a new corporate structure
Policy risks–examples include the likelihood that an initiative represents, or may be affected by, a major shift in government or agency policy, or change in legislation
public interest risks–examples include the initiative’s environmental impact and its relation to public health, safety, and security issues. risk treatment may include working with the neighbours and the community to address public concerns in the initiative planning phase
What is the time value of money?
Time value of money (TVM) is important in public-sector capital planning for organizations that will borrow money for the project or acquisition and must know the cost of the debt changes they will be paying
As they develop alternate financing schemes, the future coats of money have to be factored in assessing overall costs
The TVM technique such as net present value (NPV) can help determine the opportunity costs associated with funding the acquisition through debt or taxation
The simplest explanation of TVM is that a dollar today is worth more than a dollar tomorrow or at any time in the future, and the dollar today is worth less than the dollar you had yesterday or any time in the past
Many attribute this to inflation of the worth of the currency and compounding interest on funds borrowed
Organizations have choices about what to do with the money
This choice is called the opportunity cost, the cost being the
TVM is important in weighting the relative costs and benefits of s long-term capital program. The objective is to bring those costs onto a common field of analysis: the present value
Factors associated with the TVM
Opportunity cost
• Opportunity cost is used to mean the cost of something in terms of an opportunity foregone (and the benefits that could be received from that opportunity) or of the most valuable forgone alternative
o Spending it now means having the things that are needed now
o Investing it means deferring consumption and earning a return that will increase the value of the dollar, depending on the investment and time it is held
o Holding it, and making no decision, means deferring any use and foregoing the opportunity to either consume or earn
- risk
• The dollar in had today has little risk
• It is within the control of the organization, which can dispose of it, save it or invest it as it sees fit
• Generally, collection risk increases with distance from today, meaning a dollar owed to you tomorrow has less risk of not being paid than a dollar owed to your next year
• More things can happen to prevent the future payment in the intervening time - Interest-rate risks is also involved in the concept of time value
• Market rates fluctuate, and the expectation of whether rates will rise of fall can affect loan and investment decisions
• Today’s dollar, then, has more value than the one you get tomorrow for yet another reason: if rates decline, not having the dollar today means that the opportunity to invest at the higher rate was lost
• As with credit risk, the amount of interest-rate risk also increases the farther into the future the payment is expected
4.Inflation
• If prices are rising, that dollar in your hand will buy less tomorrow than it will today
• If you invest it, what return will be needed to keep ahead of rising prices as well as compensation for not having the use of money
