Basic Concepts Flashcards
Qualitative Characteristics of Useful Information - Primary Characteristics (Relevance)
Relevance - Capable of making a difference in a user’s decision-making process. Made up of:
- Predictive Value: Helps decision makers predict or forecast future results
- Confirmatory Value (Feedback Value): Confirms or corrects prior predictions
Qualitative Characteristics of Useful Information - Primary Characteristics (Faithful Representation)
Faithful Representation - Information depicts what it intends to represent. Made up of:
- Free from Error: No errors or emissions
- Neutrality: Free from bias
- Completeness: All information necessary to users is provided
Enhancing Qualitative Characteristics of Useful Information
Comparability – Same principles being used with business enterprises in similar Industry.
- Consistency: Same accounting methods in different periods.
Understandability – Classifying, characterizing and presenting information clearly and concisely.
Timeliness – Information is available early enough to influence decisions.
Verifiability – Independent knowledgeable observers would agree.
Constraints of Useful Information
Cost/Benefit Constraint - Cost of obtaining and presenting information should not exceed the benefits.
Materiality - Capable of making a difference in the user’s decision-making process if omitted or misstated.
Elements of Financial Statements - Assets
An economic resource that has a probable future benefit, one can obtain the benefit, and the transaction creating the benefit has already occurred.
Elements of Financial Statements - Liabilities
An economic obligation in which one needs to use or transfer an asset, it can’t be avoided and the transaction has already occurred.
Elements of Financial Statements - Equity
Assets left over after deducting liabilities. Consists of 3 elements:
- Investments by Owners (Contributions)
- Distributions to Owners (Dividends)
- Comprehensive Income: All changes in equity other than “owner” sources
Elements of Comprehensive Income
Revenues - Inflows from an entity’s primary operations.
Expenses - Outflows due to an entity’s primary operations.
Gains - Increases in equity from incidental transactions.
Losses - Decreases in equity from incidental transactions.
Capital Maintenance Concept
Physical Capital Maintenance Concept - An event is recognized when an asset is sold or a liability is settled.
Financial Capital Maintenance Concept - An event is recognized as a change in the value of an asset or liability occurs (recognizes holding gains and losses).
General Accounting Rules & Concepts - Recognition
Reporting an item in the financial statements (i.e., booking it).
General Accounting Rules & Concepts - Realization
Converting noncash resources into cash or a claim to cash.
General Accounting Rules & Concepts - Matching
Recognize a cost as an expense in the same period as the benefit (usually a revenue) is recognized.
When to Recognize Financial Statement Elements
Meets definition – The item meets the definition of an element.
Measurable – Element is capable of being measured in monetary terms.
Relevant – The item is capable of making a difference in user decisions.
Reliable – The information is faithfully represented and verifiable.
Credit Loss
A loss recognized in the income statement from the decline in value of a financial asset (eg, receivables) that results from the expected inability of the debtor to make all payments called for in the instrument.
Credit Loss - Discounted Cash Flow Method
A method used to estimate credit losses by determining the present value of the expected future cash flows.
Credit Loss - Loss-Rate Method
A method used to estimate credit losses as a percentage of total exposure.
Credit Loss - Aging Method
A method used to estimate credit losses where the instruments are stratified, often on the basis of when they will mature, and different percentages are applied to each stratum.
Credit Loss - Roll-Rate Method
A method used to estimate credit losses on the basis of the time required for the conversation cycle, the period required for instruments to be realized.
Credit Loss - Probability-of-Default Method
A method used to estimate credit losses by multiplying a likelihood that an instrument will be defaulted upon by the balance of the instrument.
Purchased Financial Assets with Credit Deterioration (PCD Assets)
A financial asset acquired with a more-than-insignificant credit deterioration, likely purchased at a larger discount because of the potential for credit loss. Such discount must be allocated between market risk and credit risk.
Fair Value Measurement
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.
Fair Value Measurement - Principal vs Most Advantageous Market
Principal Market - The market where the greatest volume and level of activity occurs.
Most Advantageous Market - The market that maximizes the price received for an asset or minimizes the price to transfer a liability.
Fair Value Measurement - Valuation Techniques
Market Approach - A valuation technique that uses prices and relevant information from market transactions for identical or comparable assets/liabilities.
Income Approach - A valuation technique that converts future revenues and expenses or cash flows into a single current amount.
Cost Approach - A valuation technique that uses the current cost of replacing the service capacity of an asset.
Fair Value Measurement - Inputs
Level I, the most reliable, involves the use of observable data from actual market transactions, occurring in an active market, for identical assets or liabilities.
Level II, also involves the use of observable data from actual market transactions but either;
- The transactions did not occur in an active market, or
- The transactions relate to similar, but not identical, assets or liabilities.
Level III, involves the use of unobservable data and are largely based on management’s judgement.
Fair Value Measurement - Steps
- Identify the asset or liability to be measured.
- Determine the principal or most advantageous market (highest and best use).
- Determine the valuation premise (in-use or in-exchange).
- Determine the appropriate valuation technique (Market, income, or cost approach).
- Obtain inputs for valuation (Level 1, Level 2, or Level 3).
- Fair value hierarchy must be used to prioritize the prioritize the inputs to valuation techniques. - Calculate the fair value of the asset.
Generally Accepted Accounting Principles (GAAP)
A general purpose financial reporting framework set forth by the FASB to be used for the preparation and presentation of financial statements.
Financial Accounting Standards Board (FASB)
The board that is responsible maintaining the FASB Accounting Standards Codification, the only authoritative source of GAAP, through the issuance of Accounting Standards Updates (ASUs) and for issuing statements on financial accounting concepts ((SFACs), the framework upon which GAAP is based.
International Financial Reporting Standards IFRS
A general purpose financial reporting framework that is comprehensive in nature, established and maintained by the International Accounting Standards Board (IASB) used for the preparation of financial statements in many countries outside of the United States and accepted, in many cases, for financial reporting within the United States.
Fair Value Option
An election that allows an entity to report virtually any of its financial assets and liabilities at fair value (when fair value measurement is not already required). When this irrevocable election is made, the item is remeasured at fair value on each balance sheet data and unrealized gains and losses are recognized in income.
Financial Instrument
Cash, ownership interests in an entity (eg, stock), and contracts (eg, derivatives, debt securities, etc.) that create both:
- an obligation to transfer, or exchange on possibly unfavorable terms, one or more financial instruments by one entity; and
- a right to receive, or exchange on possibly favorable terms, one or more financial instruments by one entity.
Notes to Financial Statements
- Summary of significant accounting policies.
- Summary of significant assumptions.
- Other notes to the financial statements.
Current Cost (Current Cost-Constant Purchasing Power Accounting)
Reporting assets at the replacement cost for assets, including the cost of a comparable used asset, when available, or the cost of a new asset adjusted for inflation when the cost of a comparable used asset is not available, indicating financial position as if all transactions had occurred at amounts appropriate on the financial statement date or for the financial statement period.
Price Level Adjusted (historical Cost-Constant Purchasing Power Accounting)
Reporting items at historical cost adjusted for changes in price level based on changes in the Consumer Price Index, indicating financial position as if all transactions occurred at historical amounts adjusted for inflation or deflation.
Purchasing Power Gain or Loss
The difference between the amount of net monetary items as of the end of the period and the amount that would have been on hand if the beginning cash balance and all transactions had occurred at year-end prices, resulting in a purchasing power loss in periods of inflation for monetary creditors and gains for monetary debtors, and the reverse in periods of deflation.
If inflation:
- Monetary Asset - Purchasing Power Loss
- Monetary :Liability - Purchasing Power Gain
Monetary Creditor (Debtor)
An entity with monetary assets that exceed monetary liabilities (creditor) or one with monetary liabilities that exceed monetary assets (debtor).
Risks and Uncertainties - Four Areas of Disclosure
- Nature of Operations
- Use of estimates\
- Certain significant estimates
- Current vulnerability associated with certain concentrations
Current Asset
An asset that will be used up or converted into cash within one year or one operating cycle, whichever is longer. An Asset is an economic resource with a probable future economic benefit that the entity obtained or controls as a result of an event or transaction that has already occurred.
Current Liability
A liability that will be settled within one year or one operating cycle, whichever is longer, or will require the use of current assets. A Liability is an economic obligation that is probable that will require the entity to transfer assets or provide services in the future as a result of an event or transaction that has already occurred.
Cash Equivalent
A security easily converted into cash with an original maturity of 90 days or less.
Financial Asset
Cash; a security, such as stock, representing ownership in another entity; a contract that gives the entity the right to receive the cash or other financial instrument; or a contract that gives the entity the right to exchange financial instruments on potentially favorable terms.
Financial Liability
A contract that requires the entity to transfer cash or another financial instrument to another party; or a contract that requires the entity to exchange financial instruments on potentially unfavorable terms.
Working Capital
Current assets - Current liabilities, measures the company’s solvency.
Current Ratio
Current Assets / Current Liabilities
Measures short-term debt-paying ability
Quick (Acid-Test) Ratio
Cash + Marketable Securities + Net Receivables / Current Liabilities
Measures immediate short-term liquidity
Current Cash Debit Coverage Ratio
Net Cash provided by Operating Activities / Average Current Liabilities,
Measures ability to pay off current liabilities in a year.
Receivables Turnover
Net Credit Sales / Average Net Trade Receivables
Measures liquidity of receivables
Inventory Turnover
Cost of Goods Sold / Average Inventory
Measures liquidity of inventory
Asset Turnover
Net Sales / Average Total Assets
Measures how efficiently assets are used to generate sales.
Number of Days’ Sales in Average Inventory
Average Inventory / Daily Cost of Goods Sold
or
365 / Inventory Turnover Ratio
Measures number of days required to sell inventory.
Number of Days’ Sales in Average Receivables
365 / Receivables Turnover
Measures number of days required to collect receivables.
Profit Margin on Sales
Net Income / Net Sales
Measures profit generated by each dollar of sales.
Debt to Equity
Total Debt / Stockholders’ Equity
Measures the entity’s ability to sustain losses.
Debt to Total Assets
Total Debt / Total Assets
Measures the percentage of assets provided by creditors.
