1.1 Basic Concepts and Framework COPY

Question 1

Who authorized the Financial Accounting Standards Board to establish accounting standards in the US?

Answer 1

Securities and Exchange Commission (SEC)

Question 2

A financial reporting framework (FRF) includes which criteria?

Answer 2

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)

Question 3

What are the two general purpose frameworks?

Answer 3

U.S. Generally Accepted Accounting Principles (GAAP),

International Financial Reporting Standards (IFRS)

Question 4

What type of companies are required to submit their financial statements to the SEC?

Answer 4

Publicly-held entities

Question 5

Are nonpublic entities required to prepare their financial statements in accordance with a general purpose framework (GAAP or IFRS)?

Answer 5

No, they may prepare them using a special purpose framework, also referred to as an Other Comprehensive Basis of Accounting (OCBOA)

Question 6

What are special purpose frameworks, also known as Other Comprehensive Bases of Accounting (OCBOA)?

Answer 6

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.

Question 7

What are some types of special purpose frameworks?

Answer 7

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

Question 8

What is the Private Company Council (PCC)? What does it do?

Answer 8

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.

Question 9

Who do the objectives of financial reporting focus on?

Answer 9

The USERS of the financial information (the financial statements)

Question 10

What is the objective of financial reporting?

Answer 10

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.

Question 11

What are the two primary qualitative characteristics of accounting information?

Answer 11

Relevance and Faithful Representation

Question 12

What attributes make accounting information Relevant?

Answer 12

Predictive Value
Confirmatory (Feedback) Value
Materiality

Question 13

What is meant by Relevance?

Answer 13

Capable of making a difference in a user’s decision making process.

Question 14

What is meant by Predictive Value?

Answer 14

Helping decision makers predict or forecast future results.

Question 15

What is meant by Confirmatory (Feedback) Value?

Answer 15

Confirms or corrects prior predictions.

Question 16

What is meant by Materiality?

Answer 16

Its omission or misstatement could influence a user’s decision (How significant an amount is in relation to the entire picture).

Question 17

What is meant by Faithful Representation?

Answer 17

Information depicts what it intends to represent.

Free from Error,
Neutrality, and
Completeness
“FENCe”

Question 18

What attributes demonstrate Faithful Representation?

Answer 18

Free from Error,
Neutrality, and
Completeness
(“FENCe”)

Question 19

What are the Enhancing Qualitative Characteristics that relate to both Relevance and Faithful Representation?

Answer 19

Comparability (Consistency),
Understandability,
Timeliness,
Verifiability (“CUT like a V”)

Question 20

What is the pervasive constraint that overrides the usefulness of information?

Answer 20

Cost vs. Benefit

cost to present shouldn’t exceed benefit

Question 21

What do a full set of financial statements include?

Answer 21

Balance Sheet, 
Income Statement, 
Statement of Cash Flows, 
Statement of Changes in Owners' Equity, 
Statement of Comprehensive Income (with IS or separate)

Question 22

What are the ten Elements of Financial Statements?

Answer 22

Assets, 
Liabilities, 
Equity (Net Assets), 
Investments by Owners, 
Distributions to Owners (i.e., Dividends), Comprehensive Income, 
Revenue, 
Expenses, 
Gains,
Losses

Question 23

What are the 3 Basic Elements of Financial Statements

Answer 23

Assets, Liabilities, Equity (Net Assets)

Question 24

What is Comprehensive Income?

Answer 24

All changes in equity (net assets) other than “owner” sources (investments and distributions)

Question 25

What four items only affect Comprehensive Income, and not net income? (U.S. GAAP)

Answer 25

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

Question 26

What is meant by Matching?

Answer 26

Recognize a cost as an expense in the same period as the benefit (usually a revenue) is recognized

Question 27

What is meant by Allocation?

Answer 27

Spreading a cost over more than one period (i.e. depreciation)

Question 28

What is meant by Recognition?

Answer 28

Booking an item in the financial statements

Question 29

What is meant by Realization?

Answer 29

Converting non-cash resources into cash or a claim to cash

Question 30

When do you recognize a financial statement element and how do you measure it?

Answer 30

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)

Question 31

What are the five different ways to MEASURE assets and liabilities in MONETARY TERMS?

Answer 31

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)

Question 32

What are the three valuation techniques utilized when measuring an item at fair value?

Answer 32

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”)

Question 33

What are the three levels of inputs used to determine appropriate fair value measurement?

Answer 33

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

Question 34

What steps summarize fair value measurement?

Answer 34

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)

Question 35

In present value accounting measurements, what is the difference between the Traditional and Expected approaches?

Answer 35

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)

Question 36

Under accrual accounting, when are revenue or gains recognized?

Answer 36

When they are earned (earnings process is complete) and realizable (cash or a claim to cash has been received)

Question 37

What is revenue?

Answer 37

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.

Question 38

What are expenses? What are the three expense categories?

Answer 38

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)

Question 39

What are gains?

Answer 39

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.

Question 40

What are losses?

Answer 40

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.

Question 41

If a material change in estimate is REASONABLY POSSIBLE, what is the appropriate response?

Answer 41

Disclose it

Question 42

If a material change in estimate is PROBABLE and ESTIMABLE, what is the appropriate response?

Answer 42

Disclose:

• Nature of uncertainty that may cause change
• estimated effect of change

Question 43

What are the Statements of Financial Accounting Concepts intended to establish?

Answer 43

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”

Question 44

Can an entity’s revenue result from a decrease in a liability from primary operations?

Answer 44

Yes (think unearned revenue)

Question 45

Relative to International Financial Reporting Standards, is U.S. GAAP more principle-based or rule-based?

Answer 45

Rule-based

Question 46

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?

Answer 46

Private Company Council (PCC)

Question 47

Which characteristic is capable of making a difference in a user’s decision making process? (comprised of Predictive Value and Confirmatory Value)

Answer 47

Relevance

Question 48

Which characteristic focuses on decision makers predicting or forecasting future results?

Answer 48

Predictive Value

Question 49

Which characteristic confirms or corrects prior predictions?

Answer 49

Confirmatory (Feedback) Value

Question 50

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)

Answer 50

Materiality

Question 51

What characteristic refers to “Information depicts what it intends to represent” and consists of Free from Error, Neutrality, and Completeness (“FENCe”)?

Answer 51

Faithful Representation

Question 52

What are all changes in equity (net assets) other than “owner” sources (investments and distributions) referred as?

Answer 52

Comprehensive Income

Question 53

What is it called when recognizing a cost as an expense in the same period as the benefit (usually a revenue) is recognized?

Answer 53

Matching

Question 54

What is it called when spreading a cost over more than one period (i.e. depreciation)?

Answer 54

Allocation

Question 55

What is it called when booking an item in the financial statements?

Answer 55

Recognition

Question 56

What is it called when converting non-cash resources into cash or a claim to cash?

Answer 56

Realization

Question 57

When are Revenues recognized?

Answer 57

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).