1.1 Basic Concepts and Framework COPY Flashcards
Who authorized the Financial Accounting Standards Board to establish accounting standards in the US?
Securities and Exchange Commission (SEC)
A financial reporting framework (FRF) includes which criteria?
Recognition criteria (what), Measurement criteria (how much/what amount), Presentation criteria (where appears on financial statements), Disclosure criteria (what and how much info is to be provided)
What are the two general purpose frameworks?
U.S. Generally Accepted Accounting Principles (GAAP),
International Financial Reporting Standards (IFRS)
What type of companies are required to submit their financial statements to the SEC?
Publicly-held entities
Are nonpublic entities required to prepare their financial statements in accordance with a general purpose framework (GAAP or IFRS)?
No, they may prepare them using a special purpose framework, also referred to as an Other Comprehensive Basis of Accounting (OCBOA)
What are special purpose frameworks, also known as Other Comprehensive Bases of Accounting (OCBOA)?
A definite set of criteria, other than U.S. GAAP or IFRS, having substantial support underlying the preparation of financial statements prepared pursuant to that basis.
What are some types of special purpose frameworks?
a) Cash basis - revenues recognized when received
b) Modified cash basis - hybrid approach between cash and accrual (assets are capitalized, taxes and inventory are accrued)
c) Tax basis - revenues and expenses recognized in same period as tax return preparation
d) Contractual basis - generally designed to assist users in determining whether the terms of the contract are being adhered to
e) Regulatory basis - one imposed by a government agency to which the entity is required to report
What is the Private Company Council (PCC)? What does it do?
Created by the FASB and charged with evaluating existing GAAP to determine if there are requirements, including disclosures, from which nonpublic entities should be exempt; or simplified accounting approaches that may be applied to transactions or financial statements that will reduce the costs of reporting without diminishing the quality/value of information.
Who do the objectives of financial reporting focus on?
The USERS of the financial information (the financial statements)
What is the objective of financial reporting?
o objective of general-purpose financial reporting is to provide information about the entity useful to current and future investors and creditors in making decisions as capital providers.
Useful information includes:
- amount, timing, and uncertainty of cash flows;
- Ability to generate future net cash inflows;
- economic resources (assets) and claims to those resources (liabilities) that provides insight into financial strengths and weaknesses, and its liquidity and solvency;
- The effectiveness with which management has met its stewardship responsibilities;
- effect of transactions and other events that change an entity’s economic resources and the claims to those resources.
What are the two primary qualitative characteristics of accounting information?
Relevance and Faithful Representation
What attributes make accounting information Relevant?
Predictive Value
Confirmatory (Feedback) Value
Materiality
What is meant by Relevance?
Capable of making a difference in a user’s decision making process.
What is meant by Predictive Value?
Helping decision makers predict or forecast future results.
What is meant by Confirmatory (Feedback) Value?
Confirms or corrects prior predictions.
What is meant by Materiality?
Its omission or misstatement could influence a user’s decision (How significant an amount is in relation to the entire picture).
What is meant by Faithful Representation?
Information depicts what it intends to represent.
Free from Error,
Neutrality, and
Completeness
“FENCe”
What attributes demonstrate Faithful Representation?
Free from Error,
Neutrality, and
Completeness
(“FENCe”)
What are the Enhancing Qualitative Characteristics that relate to both Relevance and Faithful Representation?
Comparability (Consistency),
Understandability,
Timeliness,
Verifiability (“CUT like a V”)
What is the pervasive constraint that overrides the usefulness of information?
Cost vs. Benefit
cost to present shouldn’t exceed benefit
What do a full set of financial statements include?
Balance Sheet, Income Statement, Statement of Cash Flows, Statement of Changes in Owners' Equity, Statement of Comprehensive Income (with IS or separate)
What are the ten Elements of Financial Statements?
Assets, Liabilities, Equity (Net Assets), Investments by Owners, Distributions to Owners (i.e., Dividends), Comprehensive Income, Revenue, Expenses, Gains, Losses
What are the 3 Basic Elements of Financial Statements
Assets, Liabilities, Equity (Net Assets)
What is Comprehensive Income?
All changes in equity (net assets) other than “owner” sources (investments and distributions)
What four items only affect Comprehensive Income, and not net income? (U.S. GAAP)
1) Derivative Cash Flow Hedges
2) Excess adjustment of Pension PBO and FV of plan assets at year end
3) Net unrealized gains or losses on “available-for-sale” securities
4) Translation adjustments of foreign currencies
What is meant by Matching?
Recognize a cost as an expense in the same period as the benefit (usually a revenue) is recognized
What is meant by Allocation?
Spreading a cost over more than one period (i.e. depreciation)
What is meant by Recognition?
Booking an item in the financial statements
What is meant by Realization?
Converting non-cash resources into cash or a claim to cash
When do you recognize a financial statement element and how do you measure it?
a) It meets the DEFINITION of an element (asset, liability)
b) The element is capable of being MEASURED in MONETARY TERMS
c) The item is RELEVANT and FAITHFULLY REPRESENTED (it’s useful)
What are the five different ways to MEASURE assets and liabilities in MONETARY TERMS?
1) Historical cost - amount paid for it (PP&E)
2) Replacement cost (inventory)
3) Fair Market Value (FMV, FV) - the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date
4) Net realizable value (NRV) - amount expected to be converted into (such as A/R net of allowance for doubtful accounts)
5) Present value (PV) - discounted cash flows stemming from the time value of money (Notes Receivable, Bonds Payable, Leases)
What are the three valuation techniques utilized when measuring an item at fair value?
1) Market approach - information from market transactions involving identical or comparable assets or liabilities
2) Income approach - involves analyzing future amounts in the form of revenues, cost savings, earnings, etc.
3) Cost approach - involves measuring the cost that would be incurred to replace the benefit (service capacity) derived from an asset
(“MIC”)
What are the three levels of inputs used to determine appropriate fair value measurement?
1) Level I - most reliable, involves use of observable active market data from IDENTICAL assets or liabilities
2) Level II - involves use of observable market data from SIMILAR assets or liabilities, or transactions that do not occur in an active market
3) Level III - mainly involves use of management’s judgement/forecasts
What steps summarize fair value measurement?
1) Identify asset or liability to be measured
2) identify which market to use (highest net value = share price - costs)
- include:
- transaction costs
- transportation costs
- markets:
- principle: greatest volume and level of activity
- most advantageous: can sell for max benefit
3) determine FV in chosen market
- DO use transportation costs (is characteristic part of A that anyone would have to pay)
- do NOT use transaction costs (characteristic of indiv sale)
In present value accounting measurements, what is the difference between the Traditional and Expected approaches?
Used to measure cash flows:
- Traditional approach uses the single most likely cash flow amounts
(risk/uncertainty: included in interest rate) - Expected Approach uses the weighted average of the different possibilities
(risk free rate, uncertainty in: timing and amount of possible cash flows)
Under accrual accounting, when are revenue or gains recognized?
When they are earned (earnings process is complete) and realizable (cash or a claim to cash has been received)
What is revenue?
Inflows or other enhancements to assets or settlements of liabilities as a result of delivering goods or providing services that constitute the entity’s main or central operations.
What are expenses? What are the three expense categories?
Outflows or other using-up of assets or the incurrence of liabilities as a result of providing goods or services that are central to an entity’s main operations. They can be:
1) Product expenses (cause and effect)
2) Systematically and rationally allocated (ala depreciation)
3) Period expenses (such as Selling, General, and Administrative costs)
What are gains?
Increases in equity as a result of transactions that are not part of the company’s main operations and do not result from revenues or investments by the owners of the entity.
What are losses?
Decreases in equity as a result of transactions that are not part of the company’s main or central operations and that do not result from expenses or distributions made to owners of the entity.
If a material change in estimate is REASONABLY POSSIBLE, what is the appropriate response?
Disclose it
If a material change in estimate is PROBABLE and ESTIMABLE, what is the appropriate response?
Disclose:
- Nature of uncertainty that may cause change
- estimated effect of change
What are the Statements of Financial Accounting Concepts intended to establish?
The objectives/concepts for use in developing standards of financial accounting/reporting
Not constitute GAAP –> is a direction for development of specific GAAP, a “constitution”
Can an entity’s revenue result from a decrease in a liability from primary operations?
Yes (think unearned revenue)
Relative to International Financial Reporting Standards, is U.S. GAAP more principle-based or rule-based?
Rule-based
What organization was created by the FASB and charged with evaluating existing GAAP to determine if there are requirements, including disclosures, from which nonpublic entities should be exempt; or simplified accounting approaches that may be applied to transactions or financial statements that will reduce the costs of reporting without diminishing the quality/value of information?
Private Company Council (PCC)
Which characteristic is capable of making a difference in a user’s decision making process? (comprised of Predictive Value and Confirmatory Value)
Relevance
Which characteristic focuses on decision makers predicting or forecasting future results?
Predictive Value
Which characteristic confirms or corrects prior predictions?
Confirmatory (Feedback) Value
What characteristic relates to how its omission or misstatement could influence a user’s decision? (How significant an amount is in relation to the entire picture)
Materiality
What characteristic refers to “Information depicts what it intends to represent” and consists of Free from Error, Neutrality, and Completeness (“FENCe”)?
Faithful Representation
What are all changes in equity (net assets) other than “owner” sources (investments and distributions) referred as?
Comprehensive Income
What is it called when recognizing a cost as an expense in the same period as the benefit (usually a revenue) is recognized?
Matching
What is it called when spreading a cost over more than one period (i.e. depreciation)?
Allocation
What is it called when booking an item in the financial statements?
Recognition
What is it called when converting non-cash resources into cash or a claim to cash?
Realization
When are Revenues recognized?
Revenues are recognized when EARNED - the earnings process (the provision of goods or services to the customer) is complete - and REALIZABLE - an exchange has taken place, typically cash collected, but it may include a promise to pay in the future (ala a receivable).
