Download General Principals of Accounting

Slides for Class 4
H ADM 545
January 31, 2002
General Principals of Accounting
• Financial Versus managerial accounting
• Principles of Accounting
• Conventions of Accounting
Financial Accounting
• Primary outputs of financial accounting
are four financial statements:
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Balance sheet
Statement of revenues and expenses
Statement of cash flows
Statement of changes in fund balances
• Generally accepted accounting
principles (GAAP)
• What a CPA’s audit of an HCO’s
financials means
Managerial Accounting
• Mainly for special financial reports not
governed by GAAP
• Primarily for internal users
– managers
– directors
• Uniformity and comparability of
financial information less important
Principles of Accounting
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Accounting entity
Money Measurement
Duality
Cost Valuation
– Required Return on investment (ROI) and
Valuation Alternatives
• Accrual Accounting
• Stable Monetary Unit
• Fund Accounting
Accounting Entity principle
• “Specifying the entity on which the accounting
will focus defines the information that is
pertinent.”
• Is there a board of trustees that is legally
responsible for governing the organization?
• Problem: Case where the legal entity is
different from the accounting entity
– Foundation that is the legal owner of hospitals
– Is each of these hospitals an accounting entity?
Money Measurement
• Concern that the economic resources and
obligations for accounting entities be
consistently measured
• Economic Resources: “Scarce means, ...
essential to economic activity” (ASSETS)
• Economic Obligations: “responsibilities to
transfer resources to another entity in the
future” (LIABILITIES)
• Excess of ASSETS over LIABLITIES is a
residual called OWNERS EQUITY, NET ASSETS,
or FUND BALANCE depending on how the
accounting entity is licensed.
Duality
• The value of ASSETS must always = the value
of LIABILITIES + NET ASSETS
• Thus after the monetary value of each
transaction to which the accounting entity is
posted to the proper accounts, the ASSETS
must = the LIABILITIES + NET ASSETS on the
firm’s Balance Sheet.
• What does an account in a charter of accounts
look like up close?
Cost Evaluation
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Historical or acquisition costs of assets
Valuing assets based on their market value
Replacement cost valuation of assets
How the passing of time can lead to dramatic
divergences between historical and
replacement costs of assets due to inflation or
a decline in the purchasing power of a dollar
– Remedy : Account for transactions not in dollars but
in dollars of purchasing power at a given point in
time.
Required Return on Investment and
Valuation Alternatives
• Cost of Capital is the price the investor must
pay for the cash needed to make an
investment
• The Cash flow is the revenue an entity
receives from its investments in buildings,
equipment, or programs
• Historical costs of Investment
• Replacement cost of Investment
• Current Market Value of Investment
• How decisions are driven by Return the
Investment (ROI) compared to Cost of Capital
• See Figure 4-1, p. 83 for explanation
Accrual Accounting
• “…transactions of a firm are recognized during
the period to which they relate, not… in period
in which cash is received or paid”
• Accrual accounting has its greatest impact on
statements of revenues and expenses
• Income from the sale of services are called
revenues and increase a firms fund balance or
owners’ equity
• Costs of delivering services to patients are
called expenses and decrease a firm’s fund
balance or owners’ equity
Accrual Accounting (cont.)
• Transactions recorded in the period in which
they relate (see Exhibit 4-3, p. 82)
– billing patient charges to accounts receivable accounts for revenues on date services delivered
– accepting supplier charges to accounts payable accounting for expenses on date items are delivered
• Adjustments recorded so accounts reflect
current resources and obligations (see Exhibit
4-4, p. 85)
– adjusting for services delivered but not billed revenue
– adjusting for wages and benefits earned but not paid
to workers- estimate expenses accrued but not paid
– adjusting for depreciation of equipment incurred but
not spent in the current time
Stable Monetary Unit
• “at the present time no adjustment to changes
in the general purchasing power of that unit
(dollar) is required in financial reports”
• “Currently, generally accepted accounting
principles incorporate the stable monetary
unit principle”
• What can happen if financial reports are based
on the stable monetary unit but the firms
adjust wages for inflation on the first day of
the month while patients pay for delivered
services at the end of the month. (See Exhibit
4-6, p. 86)
Fund Accounting
• “a system in which an entity’s assets and
liabilities are segregated in the accounting
records” (common for not-for-profit firms that
raise capital from donors)
• ‘Duality’ theoretically must hold for each
independent fund
• FASB pronouncement divides assets into one
of three categories:
– unrestricted net assets
– temporarily restricted net assets
– permanently restricted net assets
Conventions of Accounting
• “However, several widely accepted conventions
modify the application of these principles in
certain circumstances”
• Three conventions:
– Conservatism
– Materiality
– Consistency