1 Financial Reporting Flashcards
What is the primary objective of accounting?
To measure income
What is the most authoritative set of accounting pronouncements?
The FASB Codification
All pronouncements fall under the Codification umbrella
What are the 2 Levels of Authority within the FASB codification?
Authoritative and Non-Authoritative
How does managerial accounting differ from financial accounting?
Managerial Accounting has a timeliness focus
Managerial Accounting is not required to follow GAAP
Which financial reports are required to be filed with the SEC?
Form 10K - Annual and Audited
Form 10Q - Quarterly and Reviewed
What is the focus of financial reports for individual companies?
Focus is on the needs of users to help them make decisions and assessments about the company
Does not make assessments of the economy
What are the Primary Constraints of Financial Reporting?
Cost vs. Benefit
Materiality
What are the Secondary Constraints of Financial Reporting?
Consistency - Year vs. Year
Comparability - Company vs. Company
What are the Qualitative Characteristics of Financial Reporting?
Relevance & Faithful Representation
Relevance - Makes a difference to the user
Includes:
Predictive Value - Future Trends
Confirming Value - Past Predictions
Materiality - Could affect User Decisions
Faithful Representation
Includes:
Completeness - Nothing omitted that would impact the decision-making of a user
Neutrality - Information is presented is without bias
Free from Error - No material errors or omissions
What are the Enhancing Qualitative Characteristics of Financial Reporting?
Comparability Verifiability Timeliness and Understandability
Comparability - Allows users to compare different items among various periods
Verifiability - Different people would reach a similar conclusion on the information presented
Timeliness - Information is made available early enough to impact the decision making of users
Understandability - Information is easy to understand
How does Conservatism affect the recording of accounting transactions?
When an estimate is necessary due to uncertainty conservatism chooses the best option that won’t overstate the financial position of the company
What is an accrual?
Earned (Revenue) or Incurred (Expense) but no Cash Receipt/Outlay yet
What is a deferral?
Cash Receipt/Outlay but not Earned (Revenue) or Incurred (Expense)
What is recognition in accounting?
When an item is recorded and included in the financial statements
Describe fair value with respect to an asset
The price you would receive if you sold the asset
Assumes asset is at its highest and best value
Assumes asset is sold at its most advantageous market to get the best price possible
What market assumptions are made in a fair value assessment?
Buyer and Seller are not Related
Buyer and Seller are Knowledgeable
Buyer and Seller are able to transact - i.e. This isn’t a hypothetical transaction for Fair Value measurement purposes. The buyer actually does have the $10M to purchase the asset you’re trying to value at $10M
Buyer and Seller are both motivated to buy/sell
What items are included in a Level 1 input in the fair value hierarchy?
Price quotes or market prices
For example NYSE or NASDAQ
What items are included in a Level 2 valuation input?
Interest rates
Prime rate
What items are included in Level 3 inputs of the fair value hierarchy?
Unobservable inputs such as assumptions or forecasts
Lowest priority for valuation
What are acceptable valuation techniques for fair value?
Market approach - uses market transactions and prices to value the asset
Income approach - uses present value discounts earnings
Cost approach - uses replacement cost to value the asset
What are current assets?
Cash
Inventory or Assets expected to be converted or consumed during a business’ operating cycle
Deferred Gross Profit on Installment Sales (Contra Asset)
Receivables expected to be collected in 12 months or less
What are current liabilities?
Liabilities that will use current assets during the present operating cycle
What is an accrued liability?
Expense that has been incurred but not paid
Example: rents payable
What is a deferred revenue?
A type of current liability
Payments that have been received but cannot be recorded as revenue yet
Example: Tenant pre-pays rent - Landlord still must perform to earn it and is a liability until this happens
When are revenues recognized?
When they have been earned; i.e. company has performed
What is a gain?
Increase in equity from an activity or event that is not central to the main activities of the business
Can be operating or non-operating
What is a loss?
Decrease in equity from an activity or event that is not central to the main activities of the business
Can be operating or non-operating
What is an operating cycle?
Average time it takes to turn materials or services into Cash
What is the present value of future cash flows?
Valuation method - the current value of a future amount of money using a specific interest rate
What is historical cost?
How much an asset cost - (net of depreciation and amortization)
What is replacement cost?
How much it would cost to reacquire an asset today (Entrance Cost)
What is a market cost?
The sale price of an asset (Exit Cost)
What is Net Realizable Value?
Sale Price of an Asset - Selling/Disposal Fee
When is royalty income recognized? How is it recognized?
Recognized when earned
If the royalty % is applied against net sales then subtract the estimated return amount from the gross sales first and then apply the royalty rate
When is revenue recognized in an installment sale?
Revenue recognized upon receipt of cash
Only used when cash collection is uncertain
What is deferred gross profit?
Gross Profit that can’t be recognized until cash is received
D.GP : Gross Profit % x Accounts Receivable
Pay attention to the year if GP% varies
What is the cost recovery method?
No revenue recognized until all costs are recovered from purchase of the asset
Most conservative method of revenue recognition when collection of sale price is uncertain
What is subscription revenue? How is it recorded?
Payment has been received but performance is not complete.
As company performs revenue is recognized.
Recorded as a Deferred Revenue (Liability) on Balance Sheet
How are franchise revenues recorded?
Franchisor - Startup franchise fee revenue deferred until substantial performance
Franchisee - Costs are deferred until corresponding revenue is recognized
How do you calculate sales revenue starting from cash basis income?
Mnemonic: SPEAR-BAR
Sales (i.e. Customer Payments)
+ Ending Accounts Receivable
- Beginning Accounts Receivable
: Sales Revenue on an Accrual Basis
How do you calculate COGS starting from Cash Basis?
Mnemonic: CRAP-I
Cash Remitted (i.e. paid)
+Increase in Accounts Payable
-Increase in Inventory
:COGS on an Accrual Basis
How are discontinued operations reported? When are they used?
Reported Net of Tax after Continuing Operations but before Extraordinary Items
Company decides to cease operating a segment of its business
Includes Income (or loss) from the period plus the gain (or loss) from disposal
What qualifies as an extraordinary item? How is it recorded?
Both unusual AND infrequent
Reported Net of Tax after Discontinued Operations
Note: Usual or Infrequent Items are reported as part of Continuing Operations
What is constant dollar accounting?
Adjusts assets to reflect a consistent level of purchasing power due to inflation
Uses the Consumer Price Index (CPI)
When are expenses recognized?
When they are incurred. Accrue if not yet paid.
What are accrued expenses?
Those incurred but not paid.
Product costs - Expenses should be matched with associated revenues as they are recognized (sales commission on a used car sale)
Period costs - Expenses amortized and recognized with the passage of time
When should impaired assets be written down to fair value and expensed?
Immediately.
What major items should be classified under General & Administrative (G&A) expenses?
Office staff salaries
Office/building rent
Office supplies
Note: Sales staff salaries and portions of the building assigned to Sales should be allocated to Selling Expense not G&A
What are business start-up costs?
One-time costs for opening a new business
Expensed as they are incurred
When is interest not expensed?
Interest on projects (software) for internal use is not expensed but is instead capitalized
What are the major components of Comprehensive Income?
Net Income + Other Comprehensive Income (OCI):
Revenues/Expenses
Gains/Losses
Cumulative accounting adjustments
Reclassifications adjustments
Non-owner changes in equity
What items are considered cumulative accounting adjustments?
Foreign Currency Translation Adjustments
Unrealized gains on AFS Securities
Minimum Pension Liability adjustment for defined benefit plans
What is the purpose of a reclassification adjustment?
Avoids double counting items that were included in both Net Income and OCI
Example: AFS Securities previously included in OCI are now sold at a loss and reported on the Income Statement
Where is Comprehensive Income reported?
Reported in a Single or Combined Income Statement
What disclosures on accounting policies are required in financial statements?
Accounting Principles used
Basis of Consolidation
Inventory Pricing Methods
Depreciation Method
Amortization of Intangibles
What are some major risks and uncertainties that must be disclosed?
Nature of Operations
Use of Estimates and listing of Significant Estimates
Concentration vulnerability
According to the FASB’s conceptual framework, comprehensive income includes which of the following?
Gross Margin
Operating Income
Both.
Comprehensive income is the periodic change in equity of a business from nonowner sources. Accordingly, comprehensive income is a broad concept that embraces not only revenues, expenses, gains, and losses, but also cumulative accounting adjustments and other nonowner changes in equity. Such intermediate components as gross margin, income from continuing operations before taxes, income from continuing operations, and operating income are therefore included.
What is the underlying concept that supports the immediate recognition of a contingent loss?
Conservatism.
Under the conservatism constraint, when alternative accounting methods are appropriate, the one having the less favorable effect on net income and total assets is preferable. However, conservatism does not permit a deliberate understatement of total assets and net income. Furthermore, SFAC 5 describes “a general tendency to emphasize purchase and sale transactions and to apply conservative procedures in accounting recognition.” Recognition of a contingent loss has a less favorable effect on net income than nonrecognition.
According to the FASB’s conceptual framework, certain assets are reported in financial statements at the amount of cash or its equivalent that would have to be paid if the same or equivalent assets were acquired currently. What is the name of the reporting concept?
Replacement Cost.
Replacement (current) cost is the amount of cash that would have to be paid for a current acquisition of the same or an equivalent asset.
Which characteristics relate to both accounting relevance and faithful representation?
Timeliness, Verifiability, and Comparability.
Verifiability, timeliness, comparability, and understandability are qualitative characteristics that enhance the relevance and faithful representation of accounting information.
When bad debt expense is estimated on the basis of the percentage of past actual losses from bad debts to past net credit sales, and this percentage is adjusted for anticipated conditions, the accounting concept of
Matching is being followed.
When bad debt expense is estimated on the basis of net credit sales, a cost (bad debt expense) is being directly associated with a revenue of the period (net credit sales). This practice applies the expense recognition principle of “associating cause and effect,” also known as matching.
Which of the following characteristics of accounting information primarily allows users of financial statements to generate predictions about an organization?
Neutrality
Relevance
Timeliness
Reliability
Relevance.
Relevance is a fundamental qualitative characteristic of useful accounting information. Relevant information is able to make a difference in user decisions. It must have predictive value, confirmatory value, or both. Something has predictive value if it can be used as an input in a predictive process.
According to the FASB’s conceptual framework, an entity’s revenue may result from a(n)
Decrease in an asset from primary operations.
Increase in an asset from incidental transactions.
Increase in a liability from incidental transactions.
Decrease in a liability from primary operations.
Decrease in a liability from primary operations.
Revenues are inflows or other enhancements of assets or settlements of liabilities from activities that constitute the entity’s ongoing major or central operations. Thus, a revenue may result from a decrease in a liability from primary operations, for example, by delivering goods that were paid for in advance.
Under IFRS, all of the following are conditions that must be met for recognizing revenue from a sale of goods, except
Transaction costs can be reliably measured.
The entity has received the full consideration from the sale.
The amount of the transaction can be reliably measured.
The entity has transferred the significant risks and rewards of ownership.
The entity has received the full consideration from the sale.
Under IFRS, for a sale of goods, revenue is recognized when all five of the following conditions are met: (1) The entity has transferred the significant risks and rewards of ownership, (2) the entity has neither continuing managerial involvement to an extent associated with ownership nor effective control over the goods, (3) the amount of the transaction can be reliably measured, (4) it is probable that the economic benefits will flow to the entity, and (5) transaction costs can be reliably measured.
Which of the following is an application of the principle of systematic and rational allocation? A. Sales commissions. B. Research and development costs. C. Amortization of intangible assets. D. Officers’ salaries.
C. Amortization of intangible assets.
The expense recognition principle of systematic and rational allocation is applied to the amortization of intangible assets because of the absence of a direct means of associating cause and effect. The costs benefit a number of periods (they generate revenue in those periods) and should be systematically and rationally allocated.
Which of the following is not a characteristic of the governmental reporting environment?
A. Interperiod equity.
B. Balance sheet equity.
C. Legally binding budget.
D. Accountability.
B. Balance sheet equity.
Governmental bodies report fund balance or net position, not equity.
An accrued expense can best be described as an amount
A. Paid and not currently matched with earnings.
B. Not paid and not currently matched with earnings.
C. Not paid and currently matched with earnings.
D. Paid and currently matched with earnings.
C. Not paid and currently matched with earnings.
An accrued expense is one that has been incurred but not paid. Thus, it should be charged (matched) against revenue in the current period and recorded as a liability.
The principal benefit of a single set of global financial reporting standards is
A. Increased ease of capital flow.
B. Minimization of the amount of professional judgment required to implement them.
C. The harmonization of world financial reporting.
D. Simplified enforcement for local and national regulatory bodies.
A.Increased ease of capital flow.
The principal advantage of a single set of global financial reporting standards is that multinational companies do not have to rewrite their statements in (or perform a complex reconciliation to) the local financial reporting framework to trade their stock on the local exchange. Foreign investment is thereby made much easier, and the cost of capital is lowered.
Deb Co. records all sales using the installment method of accounting. Installment sales contracts call for 36 equal monthly cash payments. According to the FASB’s conceptual framework, the amount of deferred gross profit relating to collections 12 months beyond the balance sheet date should be reported in the
Current asset section as a contra account.
Under the installment method, a credit sale is recorded by debiting a receivable and crediting inventory and deferred gross profit. Revenue is recognized only when cash is collected. Because the essence of an installment sale is an equal change in receivables and inventory, the deferred gross profit account serves to reduce the asset valuation to the unrecovered cost of goods sold. Accordingly, deferred gross profit functions as an asset valuation (contra) account. The installment receivables (and related valuation accounts) should be classified in the current assets section of the balance sheet if they are collectible within the operating cycle. All of Deb Co.’s installment contracts are for 36 months. They are apparently related to normal operations and should be classified as current.
