 and welcome to this session in which we will keep looking at FASB's conceptual framework. In the prior two sessions, we looked at the objectives, then we looked at the elements of financial statements. And don't forget about the objectives and qualitative characteristics of the conceptual framework. What I suggest you do as always, print this picture, put it in your room. So this way you will remember those qualitative characteristics. Now, this topic is important whether you are studying for your CPA exam or studying for your accounting courses either or farhatlectures.com. Please visit my website. I can help you whether you are an accounting student or a CPA candidate, especially if you are a CPA candidate. My courses, my material does not replace your CPA review course. I am a useful addition. So you keep your review course, you use me as a supplemental tool, as a backup tool, as an alternative explanation. My courses are designed to be aligned with your CPA review course. Your risk is one month of subscription. Your potential gain is passing the exam. And if not for anything, take a look at my website to find out how well or not well your university doing on the CPA exam. I do have resources for other college courses as well as CPA review courses. The AI CPA previously released questions. My courses once again are aligned with your CPA review course. If you have not connected with me on LinkedIn, please do so. Take a look at my LinkedIn recommendation. Like this recording on YouTube, connect with me on Instagram, Facebook, Twitter and Reddit. In the previous session, we looked at the objective of FASB conceptual framework. We looked at the qualitative characteristics and we looked also at the elements of financial statements. In this session, we looked at the assumptions and principles. Again, these topics are extremely important whether you are taking the CPA exam or taking your accounting courses. Let's take a look first at the gap assumptions. So you need to know what these assumptions are, the definition. You will be expected to answer multiple choice and could be also some sort of a semi-simulation or a matching simulation of what goes with where. The first assumption is economic entity. And here what we assume, we assume that the activities by the owners of the business are kept separate from the activities of the business itself. Simply put, the owners in the business are two separate entities. So when we do accounting, we do accounting for the business. We don't do accounting for the owners of the business. So account for the business assets, the business liabilities, the business equity, separately from that of the owners. That's all what the economic entity is. The going concern basically state is a very powerful assumption. But basically what it state or what it assumes is the business, we're going to be in business, we're going to stay in business forever or for the foreseeable future. Now, this is important. It's important to make this assumption. Because if you remember when we defined an asset, when we define what is an asset, okay, we said assets are resources that provide future benefits. And based on that definition, we said something as an asset. Well, what does that mean? It means we're going to be in business in the foreseeable future. And that's an assumption we make when we do accounting. So simply put, we don't assume we're going to go out of business. Now, if we're going to go out of business, we have to take this assumption out and use liquidation value. In the absence of going out of business, we always assume we're going to be in business. So the definition of an asset basically illustrate this going concern. Also the concept of depreciation. Maybe you know what depreciation is, maybe not. Eventually, when we learn about depreciation, what we do is when we buy an asset, we take the asset and we depreciate the asset over two, three, four, five, six periods or six years or seven years or 10 years. What are we doing? We are assuming we're going to be in business for that period. And also the owner survived the business. Sorry, the business survives the owner. So if the owner passes away, the business survive. And that's especially true in publicly traded company. Think of Apple's computer, Steve Jobs passed away, Apple survived. Periodicity assumption or periodicity principle is an important concept. It basically says the life of the company can be separated into artificial time period. Now you can separate the life of the company into monthly periods. Simply put, every month, you need to report on the profitability of the company. You could report their assets, liabilities and equity, which is the balance sheet. You could break it down by quarterly or yearly. For example, the SEC, if you're a publicly traded company, you have to report quarterly and you have to report yearly. Now for private companies, it depends on your need, but at least once a year you have to do your taxes. I know what I used to work at the CPA firm. We did a lot of work for MDs, medical doctors. In MDs, they wanted monthly reports. They wanted their financial statements on a monthly basis. This way they know how well they are doing. They don't have time to do their own financial statements. Therefore, we'll prepare it for the one on a monthly basis. So this is the periodicity principle is where we have financial statements prepared based on a specific date. This is why we make adjustments at the end of every accounting period because we have to stop at some point and make a decision. And this is where we make closing. For example, we do close at the end of the year. And this is basically based on the periodicity assumption. In other words, the life of the company is broken down into artificial periods. Monetary unit basically state you have to use monetary, some sort of a currency to measure transaction. In the US, obviously we use the US dollar. If you are operating in Europe, you would use the euros depending on the current depending on which country you are reporting in. Also, with the monetary unit, you have to account for inflation if inflation is an issue. So simply put, you need to know what is economic entity going concern periodicity monetary unit. Those are easy, easy CPA questions as long as you understand the concepts. Other gap principles that you need to be aware of, which is revenue recognition, expense recognition, measurement and full disclosure. Now the first thing we want to illustrate or explain is the concept of recognition. What is recognition? Well, recognition is when do we record something in the financial statements? When do we record something on the books? When do we recognize it? Recognize, look, record, REC, REC if this will help you. When do we record something? When do we record something on the books? At what point? When do we record our revenues? When do we record our expenses? We need to know the general rules for this. Measurement is another important concept. What dollar amount do we assign? It's okay, we recorded something. But what dollar amount do we assign to that element of financial statement? Now we're going to learn about measurement that we have many measurement options that we have. We'll talk about this later once we have a whole slide about measurement. It's very important that we understand measurement. The fourth principle is full disclosure. And where is full disclosure? Simply put, you need to include any information in addition to the financial statements that could influence, that could affect the decision of the investors, of the creditors, of whoever is using the financial statements, the external users. It's not only the numbers. Let's assume you have a lawsuit. You got to let them know about this lawsuit, any commitment. Which accounting methods you are using and how do you do so? You do so by using parenthetical comments. You can do so using disclosure notes. And if you look at the financial statements, we're going to have one whole chapter about notes and how to disclose notes. Or you can do so through supplemental schedules and table explaining the details in the financial statements. So additional disclosure will help users make a better decision. So you want to give as much information as possible. Let's talk now about the revenue recognition. When do we recognize revenue? That's important. Simply put, when do we recognize revenue? Remember, we are using the accrual method. When do we recognize revenue? Well, we recognize revenue. When the earning process is complete or virtually completed. So we basically, we did the work and collectability is reasonably assured. We did the work and the customer is going to pay us. And we are kind of assured about this, reasonably assured. Nothing is assured 100%, but they're not going out of business. They're not experiencing financial difficulties. We did the work, we expect to be paid. At that point, if we did the work, we expect to be paid, the customer is capable, we can recognize revenue, even before we get paid. Fastly issued in ASU in 2014 ASU 9. And we're going to have a whole chapter about this. Basically, it says recognize revenue when goods and services are transferred, which is basically earning process is complete. And the company expect to be entitled to receive an exchange and the amount for the amount the company expect to be entitled to receive an exchange. So you would record revenue based on what you expect to receive. It can be cash and can be goods. What do you expect to receive? How much would you expect to receive? Again, we're going to have a whole chapter about revenue recognition, expense recognition, basically, or it's called sometimes the matching recognition or the matching principle, basically simply put expenses, follow revenues. It, what does that mean? It means record all expenses that help generate revenues for that particular period. And we have four approaches, usually when we record expenses. The first approach is called based on the exact cause relationship. So it's caused relationship approach. Now it's not named anything. What does that mean? What is an example of we record the expense based on cause and effect? For example, if you think cost of goods sold, when we buy a merchandiser for a retailer, or if we're manufacturing something, we're manufacturing cell phones. Okay, what we do is first we start with raw material, then raw material is transferred to work and process. Then we have labor, then we have overhead that goes into work and process. Then once something done, it becomes finished goods. It becomes finished goods, which is inventory. And it stays in inventory until we sell it. Once we sell it, that finished goods becomes cost of goods sold. Therefore, what we're saying is the expense, so we don't expense everything that we did to manufacture that cell phone until we sold it. Therefore, cost of goods sold is an example of this concept cause and effect. So the expense is a result of a sale. The cause of the expensing, the cell phone is because we sold it. Sometimes the expense could be done by associating an expense with revenues for a particular period. What does that mean? Well, think about wages. When you pay wages for your employees, you assume that those employees are working for that month or are working for that period generated revenues. When you pay your utilities, when you pay your rent for any particular month, you assume that those expenses are help generating revenues. So record expenses that help generate revenue. That's the association. Sometimes we record expenses by something called systematic and rational allocation. And this is an example of depreciation, amortization. When we buy an asset, like a long-term asset, we break the expenses into several years. So every year, we allocate a portion of that expense using a systematic and rational, for example, an equal amount or any other amount as long as that's systematic and rational. That's another form of expenses. And some expenses we have to record in the period incurred without regard related to revenue. And a good example of this is advertising. When you advertise, okay, you might say advertising, but you can say, no, that's not really true. Advertising generate revenue. It does generate revenue, but you don't know when would the advertising benefit you. You might spend money today or this month, and it may not generate any revenues for this month. It may take some time until the customer absorb the information, then when they have a need, the site to go back and buy whatever you are selling. So advertising is in the period incurred because you really don't know the cause and effect. You really don't know the cause and effect of advertising. You might advertise and get nothing, zero revenue. Nevertheless, you're expensive because you don't know what's going to happen because you don't know the future benefit of advertising. So make sure you know the expense recognition or the matching principle of expenses. Measurement, remember measurement is what dollar amount do we assign to those elements. And in measurement, in financial accounting, you learn about one measurement and you learn about historical cost. Well, that's not the only method we use to measure accounts. We have historical cost on one extreme and we have fair value on the other extreme. And we have other measurement such as net realizable value or NRV. We have replacement cost. We have current cost and we have present value. And we have obviously the fair value. But I would say historical cost and fair values are the two extreme. You can look at it that way if you choose. You can look at it that way if you choose. Historical cost, I hope you know what historical cost is. It's how much did we pay for this asset initially, the original cost, the original transaction value. And we adjust historical cost for depreciation. So we might buy a building. Then we said the building minus the accumulated depreciation will give us the book value. So we record the asset at book value. We would still show the building at historical cost. So how do we measure assets? It's what we paid for this asset, the initial measurement. Now assets could eventually be adjusted, but initially it's all recorded. All assets are initially recorded at historical cost. Liabilities are recorded at cash equivalent receive in exchange for assuming that liability. That's one measurement. The second measurement is NRV, net realizable value. You might have use the term or use this terminology maybe not basically it state the amount you would recognize the amount of cash in which the asset is expected to be converted in the ordinary course of business. This is what net realizable value. How much cash can you get for this asset? A good example for NRV is a count receivable. You might have a million dollar of a count receivable, but if you think you can only collect 900,000, then you have to subtract 100,000. And we call the 900,000 NRV net realizable value or net asset or net account receivable, not net asset net account receivable. Net realizable value is what amount of cash you would expect to receive at the end of the day. Replacement cost is the estimated selling price in the ordinary course of business minus reasonably predictable cost of completion, disposal, and transportation. A good example of this is inventory. When you report inventory, you would report it at replacement cost. And this is an application of a concept called LCM, lower of cost or market, which we will talk about later. So it's not. So you don't keep inventory at historical cost. You don't keep net realizable value at historical cost. You report them at NRV, you report them at replacement cost. Another potential measurement is called current cost. Current cost is the cost that would be incurred to purchase or reproduce the asset. The current cost is used during inflationary time, because sometime you might buy an asset and it might cost you $50,000, a piece of machinery, because you have high inflation a year later. This asset could be worth $150,000, not worth. If you want to replace it, it's worth $150,000. Therefore, keeping it at $50,000, it's misleading. Therefore, we would say you would use in current cost. Again, we use this accounting method. Thankfully, in the U.S., we don't have to worry about this because we don't have inflation, but this is another measurement method. Present value is when you record the current value of the asset or the liability based on the future cash flow. Discounted cash flow, calculating, applying the time value of money, asserting interest rate. For example, bonds are reported at the present value. Asset retirement obligation. If you don't know what these are, later on we'll talk about those, but asserting assets and certain liabilities are reported at present value of future cash flow. And we use the present value of future cash flow when we do impairment. Fair value. What's fair value is how much is the value of this asset today in the market? If you want to buy it and sell it to different parties, to independent parties, how much the buyer will sell it and how much the seller will buy it for, assuming they're not related in an orderly transaction. So the price that would be received to sell assets or pay to transfer liability in ordinary transaction between participants who are not related. Here, we are assuming no fires that means ordinary course of business. Now, fair value, believe it or not, it's much, much more involved. So what I'm going to do for fair value measurement, I'm going to devote one whole recording about fair value, because you need oftentimes fair value is easy. What do I mean by this? Sometimes fair value is just giving. For example, if a stock is publicly traded, you know it's fair value, but oftentimes that information is not giving. Therefore, you have to find the fair value. How do you find the fair value? A whole recording will be devoted for that. At the end of this recording, I'm going to remind you whether you are an accounting student or a CPA candidate to take a look at my website farhatlectures.com. No, I don't replace your CPA review course. I can be a useful addition to your CPA review course. Look, you're investing in your CPA. You're investing in yourself. You're investing in your education. You're investing in your career. Don't shortchange yourself. Give me a try for one month. Whatever you like it, you keep it. Otherwise, you cancel. I do have resources for other college university courses as well. Good luck. Study hard and of course, stay safe.