61 VOCABULARY Flashcards
Accounting Estimate
An accounting estimate is an attempt to quantify the effects of future events that cannot be known with certainty, based on assumptions and projections.
Examples of such future events whose effects must be estimated include uncollectible receivables, inventory obsolescence, useful service lives and salvage values of depreciable assets, warranty costs, periods benefited by deferred costs, and recoverable mineral reserves. Estimates require the exercise of judgment; and estimates change as new events occur, as more experience is acquired, or as additional information is obtained.
Accounting Policies
Accounting policies are the specific accounting principles, and the methods of applying those principles, that have been judged by management to be the most appropriate under the circumstances to present fairly the financial position and results of operations and statement of cash flows, in accordance with generally accepted accounting principles, and that, accordingly, have been adopted by the reporting entity for preparing financial statements.
A summary of significant accounting policies should be the first disclosure in the notes to the financial statements or may be listed in a separate section preceding the notes to financial statements (FASB ASC 235-10-50). Disclosure should emphasize those principles which are:
- a selection from existing acceptable alternatives,
- peculiar to the industry in which the reporting entity operates, or
- unusual or innovative applications of generally accepted principles.
Examples include basis of consolidation, depreciation methods, amortization of intangibles, inventory pricing, accounting for research and development costs, translation of foreign currencies, and recognition of profits on long-term construction-type contracts.
Accounting policies should not duplicate details presented elsewhere (e.g., composition of inventories or plant assets).
In governmental accounting: A summary of significant accounting policies should be included in the notes to the financial statements, a required component of the annual comprehensive financial report (ACFR). (GASB 2300.106)
Bad Debt
A bad debt is a receivable that is considered to be uncollectible. The loss in the valuation of receivables should be recognized for financial accounting purposes when the original revenue is earned even if the specific uncollectible receivables cannot be identified. For tax purposes, the loss in valuation of receivables should be recognized when the specific receivable becomes worthless.
For tax purposes, bad debts that a taxpayer incurs, and that did not arise in the course of operating a trade or business by the taxpayer, are nonbusiness bad debts. To be deductible, nonbusiness bad debts must be totally worthless. A partly worthless nonbusiness bad debt cannot be deducted. Nonbusiness bad debts are treated as short-term capital losses. (IRC Section 166)
Business bad debts that become wholly worthless during the tax year are deductible. Business bad debts that are partially worthless may be partially deductible according to IRC Section 166.
Contingency
A contingency is an event or condition that may occur in the future but that cannot currently be predicted. It has an uncertain outcome. The outcome of that event will change an existing condition or resolve a current uncertainty.
A contingency is classified in one of the following three ways:
Probable—likely to happen
Reasonably possible—may happen, but neither likely nor remote
Remote—not apt to occur
FASB ASC 450-30-25-1 applies conservatism to a contingency (losses recognized now and gains when realized). The standard requires that a loss contingency that is probable and whose amount can be reasonably estimated be accrued by debiting an expense and crediting a liability or a contra asset, as well as disclosing the uncertainty in the notes to the financial statements. If the loss contingency cannot be estimated but is reasonably possible, it must be disclosed in the notes to the financial statements. If the loss contingency is remote, then the auditor should document the rationale for this decision and no adjustment or disclosure is required.
A gain contingency, on the other hand, is not recorded until the event occurs that establishes the gain.
Credit Risk
Credit risk is the possibility that a loss may occur from the failure of another party to perform according to the terms of a contract.
Disclosure
The dictionary definition of the term “disclosure” is “revealing or uncovering.” In general, the purpose of financial reporting is to reveal an entity’s financial information. Often, the term “disclosure” relates to stating additional facts or explanations in a financial statement or auditor’s report. In financial statements, disclosure can be achieved by parenthetical or additional reporting of information after a line item by cross-referencing to another item, by footnotes, and by supplementary verbal and scheduled information. An additional explanatory paragraph can also be added to an auditor’s standard opinion for disclosure purposes.
Disclosure
The dictionary definition of the term “disclosure” is “revealing or uncovering.” In general, the purpose of financial reporting is to reveal an entity’s financial information. Often, the term “disclosure” relates to stating additional facts or explanations in a financial statement or auditor’s report. In financial statements, disclosure can be achieved by parenthetical or additional reporting of information after a line item by cross-referencing to another item, by footnotes, and by supplementary verbal and scheduled information. An additional explanatory paragraph can also be added to an auditor’s standard opinion for disclosure purposes.
Inventory
The aggregate of items of tangible personal property owned by the business (to which the firm has legal title) intended either for internal consumption in the production of goods for sale or for sale is considered inventory. The balance of costs applicable to goods on hand, including raw materials (for use in the production process), intermediate products and parts still in the production process (work-in-process), and finished goods is also considered inventory.
The major objective of accounting for inventories is to facilitate the determination of income. This is achieved through the proper valuation of inventories—the measurement of the value of the current assets and inventories, and the measurement of the related expense and cost of goods sold.
The basis of inventory accounting is cost. Inventories are valued at acquisition or production cost, which is generally held to be the sum of the purchase price plus indirect acquisition costs (freight, insurance, and handling) for purchased goods and the sum of direct materials, direct labor, and allocated factory overhead (i.e., the appropriate general and administrative costs that are clearly related to production) for manufactured goods. Selling, general, and administrative costs not directly related to production should be expensed rather than included in the valuation of inventory, which involves the use of judgment.
Standard costs may be used for inventory pricing so long as they are adjusted at reasonable intervals to reflect current conditions.
Valuation (pricing) of inventories involves:
- determination of physical quantity (number of units) and
- unit cost (in dollars).
Unit cost depends on the choice from among various alternative pricing (cost flow) assumptions:
- last-in, first-out (LIFO),
- first-in, first-out (FIFO),
- weighted average, and
- specific identification.
Consideration must also be given to the cost principle (i.e., the lower-of-cost-or-market rule (LCM)).
Inventories must be compiled periodically (physical count) and valued and compared to the amounts recorded in the accounts. Accounting records can be maintained under a periodic or perpetual system.
FASB ASC 330-10
Market Risk
Market risk is the possibility that future changes in market prices may make a financial instrument less valuable or more onerous.
If a 10% change in the market index is accompanied by a change of 12% in the price of a particular stock, the market risk of the stock is 12 ÷ 10 = 1.2.
Usually, market risk is estimated as the slope coefficient in a simple regression of monthly or weekly returns for the stock on the corresponding returns for the stock market.
For fixed-income securities, the market risk represents the risk of change in value of securities due to change in the interest rates. The value of existing fixed-rate securities varies inversely with the interest rates. When rates go up, market values go down, so that (for similar security) yields will be similar.
Measurement
Measurement is the choice of an attribute and unit of measure by which to quantify a recognized item.
SFAC 5.65–.72
Items reported in financial statements are measured by different attributes, depending on the nature of the item and the relevance and reliability of the attribute measured. Following are the five measurement attributes for assets and liabilities currently used:
Historical cost (proceeds): the amount of cash, or its equivalent, paid to acquire the asset (received to incur the liability). It is used for property, plant, and equipment, and most inventories. (It is also called “historical exchange rate” or “transaction-based.”)
Current cost: replacement cost; the amount of cash, or its equivalent, that would have to be paid currently to acquire the same asset. Current cost is used for some inventories.
Current market value: the amount of cash, or its equivalent, that could be obtained by selling the asset. It is used for some investments in marketable securities and liabilities involving marketable commodities.
Net realizable value: settlement value; the nondiscounted amount of cash, or its equivalent, that is expected to be received (paid) upon conversion (liquidation) of the asset (liability) in due course of business less direct costs. Net realizable value is used for short-term receivables and some inventories, trade payables, and warranty obligations.
Present value: the present, or discounted (at the implicit or historical rate), value of future cash flows. It is used for long-term receivables and payables.
SFAC 5.67
Measurement scale or unit of measurement is nominal units of money (i.e., unadjusted for changes in purchasing power).
Notes to Financial Statements
Notes are pieces of information disclosed in notes added to the end of financial statements, or parenthetically on the face of the financial statements, which amplify or explain, and are essential to the understanding of information recognized in the financial statements. Notes are considered integral parts of the financial statements prepared in accordance with GAAP. (SFAC 5.7)
Information presented in notes includes the following:
Significant accounting principles used
Alternative measures for assets and liabilities
Information about long-term obligations (when due, the interest rate, restrictive covenants)
Inventory measurement method used (LIFO, FIFO, etc.)
Revenue recognition policies
Discussion of contingencies, claims, and assessments
Notes to Financial Statements
Notes are pieces of information disclosed in notes added to the end of financial statements, or parenthetically on the face of the financial statements, which amplify or explain, and are essential to the understanding of information recognized in the financial statements. Notes are considered integral parts of the financial statements prepared in accordance with GAAP. (SFAC 5.7)
Information presented in notes includes the following:
Significant accounting principles used
Alternative measures for assets and liabilities
Information about long-term obligations (when due, the interest rate, restrictive covenants)
Inventory measurement method used (LIFO, FIFO, etc.)
Revenue recognition policies
Discussion of contingencies, claims, and assessments
Patent
A patent is the exclusive right granted by a government to an inventor to use, sell, manufacture, or control the invention for a specified period of time. A patent is an intangible asset that is identifiable and separable, may be purchased or developed internally, and has a legal life of 17 years (useful life may realistically be shorter than 17 years). Patents are recorded at cost and amortized straight-line over the shorter of the useful life or 17 years.
Probable
If an event is probable, the future event or events are likely to occur.
FASB ASC Glossary
Realization
Realization is the process of converting noncash resources and rights into money (specifically, the sales of assets for cash or claims to cash—thus, realized (unrealized) refers to revenues or gains or losses on assets sold (or unsold).
SFAC 6.143
Realized and recognized are not synonymous.
Warranty
A warranty is a statement regarding the quality or quantity of the goods that are the subject of a sales contract. The objective is to protect the consumer. The Uniform Commercial Code (UCC) makes express some warranties that were implied under common law. A warranty may be express or implied.
UCC 2-312–318
Warranty of title is a warranty provided by the seller that the:
title is good,
transfer is rightful, and
goods are delivered free of any security interest or lien.
Express warranty is a warranty that the goods shall conform, which rests on the “bargained for” aspects of the individual agreement and goes so clearly to the essence of the bargain that words of disclaimer are repugnant. It is created by the following (may be oral or written):
Any affirmation of fact (of existing conditions) or promise (of future performance of the goods) made by the seller to the buyer that relates to the goods and becomes a basis of the agreement; expressions of value or opinion and “puffing” do not create a warranty.
Any description of the goods in words, pictures, drawings, or specifications (e.g., in contract, in catalog, on box containing the goods)
Any sample or model
Implied warranty is a guarantee that rests so clearly on a common factual situation or set of conditions that it is automatically imposed on the goods by operation of law without any agreement or consent of the parties and can be excluded or modified only by specified procedures.
Merchantability is that goods shall be fit for the purpose for which they are sold. It applies only to merchants who deal in the type of goods being sold. To be merchantable, goods must:
pass without objection in the trade under the contract description,
be of fair average quality as described (applies to fungible goods only),
be fit for the ordinary purpose for which such goods are used,
be within the variation of an even kind, quality, and quantity within each unit and among all units,
be adequately contained, packaged, and labeled as required by the agreement, and
conform to the promises or affirmations of fact made on the container or label (if any).
Fitness for a particular purpose is imposed on the seller if:
the seller has actual or constructive knowledge of the particular purpose for which the buyer needs the goods,
the seller must furnish or select the goods, and
the buyer must rely on the seller’s skill or judgment to select or furnish the goods.
