Chapter 3 - The measurement fundamentals of financial accounting. In this chapter students will be able to: Identify and describe the four basic assumptions of financial accounting, define the principle of objectivity and describe how it determines the dollar values that appear on the financial statements. | 1 Chapter 3: The Measurement Fundamentals of Financial Accounting 2 Basic Assumptions of Financial Accounting Basic assumptions are foundations of financial accounting measurements The basic assumptions are: Economic entity Fiscal period Going concern Stable dollar 3 Economic Entity A company is assumed to be a separate economic entity that can be identified and measured. This concept helps determine the scope of financial statements. Examples — Disney and ABC, Comcast and NBC. 4 Fiscal Period (Periodicity) It is assumed that the life of an economic entity can be broken down into accounting periods. The result is a trade-off between objectivity and timeliness. Alternative accounting periods include the calendar or fiscal year. 5 Going Concern The life of an economic entity is assumed to be indefinite. Assets, defined as having future economic benefit, require this assumption. Allocation of costs to future periods is supported by the going concern assumption. 6 Stable Dollar (Monetary Unit) The value of the monetary unit used to measure an economic entity’s performance and position is assumed stable. If true, the monetary unit must maintain constant purchasing power. Inflation, however, changes the monetary unit’s purchasing power. If inflation is material, the stable dollar assumption is invalid. 7 Valuations on the Balance Sheet There are a number of ways to value assets and liabilities on the balance sheet: Input market: cost to purchase materials, labor, overhead Output market: value received from sales of services or inventories Alternative valuation bases Present value Fair market value Replacement cost Original (historical) cost 8 Present Value as a Valuation Base Discounted future cash inflows and outflows For example, the present value of a notes receivable is calculated by determining the amount and timing of its future cash inflows and adjusting the dollar amounts for the time value of money. 9 Fair Market Value as a Valuation Base Fair market value | 1 Chapter 3: The Measurement Fundamentals of Financial Accounting 2 Basic Assumptions of Financial Accounting Basic assumptions are foundations of financial accounting measurements The basic assumptions are: Economic entity Fiscal period Going concern Stable dollar 3 Economic Entity A company is assumed to be a separate economic entity that can be identified and measured. This concept helps determine the scope of financial statements. Examples — Disney and ABC, Comcast and NBC. 4 Fiscal Period (Periodicity) It is assumed that the life of an economic entity can be broken down into accounting periods. The result is a trade-off between objectivity and timeliness. Alternative accounting periods include the calendar or fiscal year. 5 Going Concern The life of an economic entity is assumed to be indefinite. Assets, defined as having future economic benefit, require this assumption. Allocation of costs to future periods is supported by the going concern assumption. 6 Stable Dollar .
