Principles Based versus Rules Based

IFRS tends to be stated as in the form of broad principles. In contrast, much of GAAP tends to be stated in the form of
bright-line rules. For example, as you will learn later along with various accounting rules, under GAAP if a term of a
lease is equal to 75 percent of the economic life of the leased property, the lease will be accounted for as a capital
lease. On the other hand, if the lease item is equal to 74 percent or less of the leased property's economic life, the lease
will be accounted for as an operating lease. IFRS takes a different approach. It makes the distinction between a capital
and an operating lease based on which party - the lessor or the lessee - substantially bears the risk and reward of
ownership.

The distinction between the principle based and rule based accounting standards is important. Under a principle
standards model, the accounting for transactions is more likely to reflect the substance of the transaction. Under a
rule based standards model, the accounting for a transaction is more likely to reflect the form of the transaction.

As GAAP and IFRS converge, it is anticipated that GAAP will become more principle based.

Owners' Equity is the residual interest of the entity's owners in the company's assets. It is the amount remaining after
liabilities are deducted from assets.

Liabilities and owners' equity are financing sources for those resources or assets

The historical cost concept requires that transactions be recorded in terms of their actual price or cost at the time
the transaction occurred.

While IFRS favors the historical cost model, it does present as an acceptable alternative treatment the revaluation of
land and buildings to their market value, if their value can be measured reliably subsequent to their initial recognition
at cost.

While there is no single ideal current ratio, financial statement users often employ the rule-of-thumb that a
healthy business will have a minimum current ratio of 2. Because the appropriate current ratio varies by
industries, financial statement users tend to focus on an entity's current ratio relative to those of other, similar
businesses. In the U.S., the pharmaceutical industry has had an average current ratio of 1.8 over the past
decade; the software industry, on the other hand, has had a 2.9 average current ratio over the same time period.
Software companies, with their limited need for fixed assets, traditionally hold a much larger proportion of their
assets in cash and monetary current assets, and this is reflected in their significantly higher current ratios.

If financial statement users notice that an entity has a current ratio that significantly higher than that of its peers,
they may be concerned that the entity holds more cash or inventory than a business needs. This may signal that
it is locking up potentially productive capital. If, on the other hand, an entity has current ratio that is significantly
lower than that of its peers, financial statement users may question its ability to satisfy its current obligations in a
timely manner.

There is no single ideal total debt to equity ratio. Over the past couple of decades, in the U.S., the average total
debt to equity ratio for public companies has ranged from 0.5 to 1.0. However, it can vary considerably from one
industry to another. Businesses in stable industries with tangible assets that make good collateral tend to borrow
heavily to finance those investments, so they tend to have high total debt to equity ratios. In contrast, volatile
businesses with few tangible assets tend to have low total debt to equity ratios. In the U.S., the software industry,
which traditionally holds very little debt, has had a 0.10 average total debt to equity ratio over the past decade.
On the other hand, financial firms, which traditionally are very highly leveraged, have had a total debt to equity
ratio of 3.3 over the same time period.
 If a company has a total debt to equity ratio that is significantly higher than that of its peers, financial statement
users may be concerned about its ability to make the required payments to its debt holders and the company's
long-term solvency may be questioned.

If, on the other hand, a company has a total debt to equity ratio that is significantly lower than that of its peers,
financial statement users may question whether the company is being aggressive enough in pursuing profitable
growth opportunities by raising debt when necessary to finance those opportunities.

As with other financial ratios, there is no single perfect total debt to equity ratio for any business. What is
important is a company's total debt to equity ratio relative to those of other, similar businesses, and also how the
ratio changes over time.

In summary, two events change the retained earnings account during an accounting period. First, the Net
Income (loss) earned by the entity during the period increases (decreases) the retained earnings account.
Second, any dividends paid (distributions made to investors) during the period reduce the retained earnings
account.

The payment of dividends is not an expense; it is a distribution of equity capital to investors. Hence, the payment
of dividends is not recorded on the income statement; instead, it directly reduces the retained earnings account.

Realization is the process of converting assets, such as merchandise for sale, into cash, cash equivalents, or good
accounts receivable.

The Matching Concept stipulates that expenses should be recognized in the same
period as the relevant revenues are recognized

Conservatism in financial accounting means that an entity should recognize only those revenues for which there
is a high degree of confidence that they will be earned and realized.

Expenses, on the other hand, should be recorded as soon as they seem likely to be incurred. If the entity is
uncertain whether to recognize an expense or about the amount of an expense, the conservatism concept
encourages it to pro-actively estimate the cost and record the expense.

The conservatism concept also applies to the balance sheet. It suggests prudence in the recording of assets
(record when reasonably certain) and in the recording of liabilities (record as soon as reasonably possible).
Further, if two different estimates of a balance sheet amount were equally acceptable, the conservatism concept
would guide accountant to record the smaller amount when measuring assets and the larger amount for
liabilities.