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FMVA > Accounting Principles and Standards > Flashcards

Accounting Principles and Standards Flashcards

1
Q

List

The 12 Fundamental Accounting Principles

A
  1. Accrual Basis of Accounting
  2. Revenue Recognition
  3. Historical Cost
  4. Matching
  5. Materiality
  6. Conservatism
  7. Economic Entity
  8. Going Conern
  9. Monetary Unit
  10. Full Disclosure
  11. Consistency
  12. Objectivity
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2
Q

Define

Accrual Basis of Accounting Principle

A

States that the financial aspects of economoic events are recorded in the accounting period in which they occur regardless of whether cash bas been exchanged.

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3
Q

Define

Revenue Recognition Principle

A

States that revenue is earned and recognized upon product delivery or service completion without regard to the timing of cash flow.

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4
Q

Define

Historical Cost Principle

A

States that assets and liabilities are recorded at the cost at which they were acquired or assumed, where cost refers to the original amount expended to acquire the item.

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5
Q

Define

Matching Principle

A

States that the costs of doing business should be recorded in the same period as the economic benefits they generate, irrespective as when they are actually paid.
* Ex: Depreciation expense - the cost of fixed asset is allocated over its useful life as it generate benefits over that time.

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6
Q

Define

Materality Principle

A

States that financial information is material to the financial statements if it would change the opinion or view of a reasonable person.
* It is important to note that the concept of materality is relative in size and importance - what could be ‘material’ to one company may not be for another.

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7
Q

Define

Conservatism Principle

A

Provides guidance on how to record transactions particularly those involving uncertainty or estimates. If a situation arises where there are two acceptable alternatives for reporting an item, the alternative that will result in smaller net income and/or asset balances should be used.
* Ex: Potential losses from Lawsuits - assumes the worse case scenario.

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8
Q

Define

Economic Entity Principle

A

States the following: (1) transactions carried out by a business are separated from its owner and (2) transactions carried out by different businesses must be accounted for separately. This allows financial statement users to assess the value and performance of a business separately from its ownership activity.
* Ex: a business owner purchases an asset with funds from his personal bank. Thus, the asset cannot be recorded on the financial statements according unless it is sold or contributed to the company.

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9
Q

Define

Monetary Unit Principle

A

States that only business transactions that are quantifiable and can be expressed in terms of monetary units are recorded in the financial statements. Also, monetary units must be stable, reliable, relevant, and useful to all companies.
* Ex: Immediate value of new executives cannot be expressed in monetary units and thus should not be recorded in the accounting records.

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10
Q

Define

Going Concern Principle

A

States that the financial statements are prepared assuming the organization will continue to operate its business for the foreseeable future. Thus, every decision is taken with the objective of operating the business rather than liquidating it.

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11
Q

Define

Full Disclosure Principle

A

States that any information that would be considered material to a user of the financial statements should be disclosed in the statements or the footnotes thereto.
* Examples include: material loss, audited financial statements, changes in policies, non-monetary transactions, etc.

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12
Q

Define

Consistency Principle

A

States that consistent information is prepared using the same accounting methods for similar events and transactions over time. This is crucial for comparative purposes.
* Example: a change in the accounting policy dealing with a company’s inventory valuation. Assuming the reasons are justified, the change must be applied consistently the following year

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13
Q

Define

Objectivity Principle

A

States that accounting records and financial statements should be independent and free from bias (verifiable).
* Example: an accountant preparing a company’s financial statement needs to verify AR. The accountant needs to be referencing supporting documents (invoices, receipts, etc.) rather than relying on the company system’s number.

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14
Q

Answer the following:

What are the two fundamental characteristics for financial information to be useful?

A
  1. Relevant (must have predictive and confirmatory value)
  2. Faithfully represents what it purports to (free from errors, complete and neutral/no bias)
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15
Q

Answer the following:

What are the four enhancing characteristics for financial information to be useful?

A
  1. Comparable
  2. Verifiable (same conclusions can be arrived from same information by knowledgeable/indepedent observers)
  3. Timely
  4. Understandable
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16
Q

Define

Confirmatory value

Part of what is considered as “relevant” for a financial statement

A

Information that provides feedback about (confirms or changes) previous evaluations

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17
Q

Define

Lease

A

A contract that conveys the right to control the use of an indentified asset for a period of time in exchange for consideration.

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18
Q

List the following:

The two criteria for a right to control be conveyed for a lease

A
  1. Right to obtain substantially all (>= 90%) of the economic benefits
  2. Right to direct to use of the asset
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19
Q

Answer the following:

What is the difference between Accounting treatment of leases between IFRS and US GAAP?

A

All leases are classified as ‘finance’ leases under IFRS, but US GAAP separates leases into (1) operating and (2) finance/capital leases.

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20
Q

Answer the following:

How do you recognize the commencement of leases on the balance sheet?

Lessee-side ONLY

A
  1. Debit “Right-of-use Asset” - asset side
  2. Credit “Lease Liability” - liability side
    * Note: ALL leases (finance/operating) will be recognized the SAME on the balance sheet
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21
Q

Define:

Lease Liability

Lessee-side ONLY

A

PV of the remaining lease payments that is discounted at either the rate implicit in the lease, OR, assuming this is not readily available, the lessee’s incremental borrowing rate (IBR).

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22
Q

Define:

Right-of-Use Asset

Lessee-side ONLY

A

The amount of the lease liability at lease commencement + lease payments made before commencement date (minus any lease incentives received) + initial direct cost incurred.

23
Q

Answer the following:

Over the lease term, what is the impact of subsequent recognition and measurement on our financials?

A

The right-of-use asset must be amortized and interest expense on the lease liability must be recorded. This will impact the income statement and how the lease is classified will play a factor.

24
Q

Answer the following:

On a Finance / Capital Lease, how are we to record subsequent recognition and measurement?

A
  1. Record interest expense - which is based on the outstanding lease liability balance
  2. Record amortization expense - this will be the straight-line over the shorter of the lease term or the asset useful life
25
Q

Answer the following:

On a Operating Lease, how are we to record subsequent recognition and measurement?

A

Record Lease Expense - which is a combination of both the interest expense and amortization expense

  1. Interest expense - which is based on the outstanding lease liability balance
  2. Amortization expense - this will be the difference between the average annual lease payment and interest expense
26
Q

Answer the following:

What are the differences when comparing finance and operating lease when evaluating expenses?

A

For finance lease:
a) Total expenses are usually higher in earlier periods and decrease over time
b) Amortization expense remains constant during the lease term (straight-line depreciation)
c) Interest expense decreases over time as the lease liability is reduced each year
For operating lease:
a) Total lease expense equals to the annual lease payment and is constant over the lease term if the lease payments are the same every year

27
Q

Define:

Income Tax Expense

A

The total amount included on the income statement for the period and is the summation of the current and deferred tax expenses.

28
Q

Define:

Current Tax Expense

A

The amount of tax due to tax authorities in the current period.

29
Q

Define:

Deferred Tax Expense

A

The amount of tax due to tax authorities in future periods.

30
Q

Define:

Accounting Income

A

The profit or loss for a period before deducting tax expense. This is commonly known as “EBT” or Earning/Income Before Tax.

31
Q

Define:

Taxable Income

A

The profit or loss for a period determined in accordance with rules established by taxation authorities. This is the taxable income on tax returns.

32
Q

Answer the following:

Because income taxes are based on taxable income and not accounting income, how do we reconcile accounting income into taxable income?

A

Starting with Accounting Income:
“+” Expenses not deductible under tax laws but recognized for accounting purposes
“+” Income included under tax laws but not recognized for accounting purposes
“-“ Expenses deductible under tax laws but not recognized for accounting purposes
“-“ Income not included under tax laws but recognized for accounting purposes
= Taxable Income

33
Q

Answer the following:

Convert this example from Accounting Income to Taxable Income

A
Answer
34
Q

Define:

Carrying Amount

A

The net book value of an asset or liability recorded on a company’s balance sheet for accounting purposes

35
Q

Define:

Tax Base

A

The amount attributed to an asset or liability for tax purposes

36
Q

Define:

Temporary Differences

A

Differences between the carrying amount of assets and liabilitites for accounting purposes and their respective tax bases (or Carrying amount - Tax Base).

37
Q

Define:

Permanent Differences

A

Differences between the tax and financial reporting of revenue or expense items which will NOT be reversed in the future.

38
Q

Define and list occurances:

Deductible Temporary Differences

A

Differences that result in amounts that are deductible in determining taxable income of future periods. They give rise to Deferred Tax Assets.

These generally arise when:
1. Taxable Income > Accounting Income
2. Assets’ Tax Base > Carrying Amount
3. Liabilities’ Carrying Amount > Tax Base

39
Q

Define and list occurances:

Taxable Temporary Differences

A

Differences that result in amounts that are taxable in determining taxable income of future periods. They give rise to Deferred Tax Liabilities.

These generally arise when:
1. Accounting Income > Taxable Income
2. Assets’ Tax Base < Carrying Amount
3. Liabilities’ Carrying Amount < Tax Base

40
Q

Define and list occurances:

Deferred Tax Assets

A

The amounts of income tax recoverable in future periods.

41
Q

Define and list occurances:

Deferred Tax Liabilities

A

The amounts of income tax payable in future periods.

42
Q

Define:

Share-based payment (SBP) transactions

A

Occur when an entity receives good and services from a third-party and grant equity instruments or cash amounts based on the value of such equity instruments as consideration.

43
Q

List:

The (5) key elements of share-based payments

A
  1. SBP Classifications (equity-settled vs. cash-settled)
  2. Grant Date
  3. Vesting Conditions
  4. Vesting Period
  5. Fair Value at Grant Date
44
Q

Define:

Equity-settled Payments

A

Occur when transactions are settled using an entity’s own equity instruments. For example: stock options

45
Q

Define:

Cash-settled Payments

A

Occur when transactions are settled in cash, the amount of which is based on the value of an equity instruments. For example: share appreciation rights

46
Q

Define:

Business Combinations

A

A transaction or other event in which an acquirer obtains control of one or more businesses

Important to note the difference b.w asset acquistion and business comb.

47
Q

List:

The (4) key elements business combinations

A
  1. Business - integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing G/S to customers, generating investment income or other income from ordinary activities
  2. Acquisition Date - the date on which the acquirer obtains control of the acquiree
  3. Acquirer - the entity that obtains control of the acquiree
  4. Acquiree - the business or businesses that the acquirer obtains control of in a business combination
48
Q

Define:

Fair Value Concentration Test

A

Designed to quickly identify whether a transaction is more akin to an asset acquisition or business combination.

49
Q

Define and list:

The Accounting Treatment for Business Combination

A

The acquisition method is used to account for business combinations and it has four steps:
1. Identify the Acquirer
2. Determine the Acquisition Date
3. Recognize (recognition principle) and measure the assets acquired, and the liabilities assumed (at fair-value when acquired - measurement principles)
4. Recognize and measure goodwill

50
Q

Define/List formula:

Goodwill

A

Represents the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognized.

Goodwill = Consideration Transferred - Fair Value of Net Asset Acquired

Note: Fees such as transaction cost, advisory, financing fees, etc. are EXCLUDED from ‘Consideration Transferred’

51
Q

Define:

Financing Fees

A

Represents the 3rd-party fees incurred by the company when it raise its debt or/and equity.

Ex: Debt Issurance Costs & Share Issue Costs

52
Q

Define:

Debt Issurance Cost

A

Represents the costs incurred by a company when they raise new debt. These costs are recognized initially on the balance sheet as a contra account under liabilities, and then amortized over the term of the related debt liability.

Examples: Registration Costs, Underwriting Fees, Legal and Accounting Fees, and other Directly Attributable Costs

53
Q

Define:

Share Issue Cost

A

Represents the costs incurred by a company when they issues to the public. These costs DIRECTLY REDUCE THE PROCEEDS a company receives from an equity offering.

Examples: Registration Fees, Underwriting Fees, Legal and Accounting Fees, and Marketing / Administrative Costs

54
Q

Define:

Transaction Costs

A

Represents the costs incurred by both acquirers and targets during the course of an M&A transaction. They represent services that have been rendered to and consumed by the acquirer and are expensed as they are incurred.

Examples: Financial Advisory, Legal Fees, Accounting Fees & Related Administrative Costs

FMVA (4 decks)

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