Chapter 1 Flashcards
Who are the providers of financial information?
- Profit-oriented companies
- Not-for-profit entities (e.g. government entities, charitable organizations, schools)
- Households
What is the primary focus of financial accounting?
The primary focus of financial accounting is on the information needs of investors and creditors.
Who are the external user groups?
- Investors
- Creditors
- Employees
- Labor Unions
- Customers
- Suppliers
- Government regulatory agencies
- Financial intermediaries
Shareholders receive cash through:
- Dividends
2. Sale of Stock
Creditors receive cash through:
- Interest
2. Repayment of Principle
Accounting information should help investors and creditors evaluate the __________, __________, and __________ of the enterprise’s future cash flows.
- amount
- timing
- uncertainty
How are revenue and expenses recognized in cash basis accounting?
- Revenue is recognized when cash is RECEIVED.
2. Expenses are recognized when cash is PAID.
How are revenue and expenses recognized in Accrual accounting?
- Revenue is recognized when EARNED.
2. Expenses are recognized when INCURRED.
What is the main objective of the International Accounting Standards Board (IASB)?
It’s main objective is to develop a single set of high quality, understandable, and enforceable global accounting standards to help participants in the world’s capital markets and other users make economic decisions.
To be useful for decision making, information should possess the qualities of __________ and/or __________.
- Relevance
2. Faithful representation
What is relevance?
Relevance means that information must possess predictive value and/or confirmatory value, typically both. (i.e. the ability of reported earnings to predicting a company’s future earnings)
When is information considered material?
Information is material if it has an effect on decisions.
What is faithful representation?
Faithful representation means agreement between a measure and a real-world phenomenon that the measure is supposed to represent.
Faithful representation requires that information be __________, __________, and __________.
- Complete
- Neutral
- Free from error
When is a depiction complete?
A depiction is complete if it includes all information necessary for faithful representation.
What is neutrality?
Neutrality implies freedom from bias.
What does it mean when information is free from error?
It means that there are no errors or omissions in the description of the amount or the process used to report the amount.
What is conservatism?
Conservatism means that accountants require greater verification before recognizing good news than bad news.
However, conservatism is inconsistent with neutrality.
Identify the four enhancing qualitative characteristics accounting information should possess:
- Comparability (including consistency)
- Verifiability
- Timeliness
- Understandibility
What is comparability?
Comparability helps users see similarities and differences between events and conditions.
What is consistency?
Accounting information is consistent if it is measured and reported the same way in each time period.
What is verifiability?
Information is verifiable if different measurers would reach consensus about whether it is representationally faithful.
What is timeliness?
Information is timely if it is available to users before a decision is made.
What is understandability?
Information is understandable if users can comprehend it.
When is information considered cost effective?
Information is cost effective only if the benefit of increased decision usefulness exceeds the costs of providing that information.
What are the 10 elements of financial statements?
- Assets
- Liabilities
- Equity (or net assets)
- Investments by owners
- Distribution to owners
- Comprehensive income
- Revenues
- Expenses
- Gains
- Losses
What are assets?
Probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events.
What are liabilities?
Probably future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events.
What is equity (or net assets)?
Called shareholder’s equity or stockholder’s equity for a corporation, it is the residual interest in the assets of an entity that remains after deducting its liabilities.
What are investments to owners?
Increases in equity of a particular business enterprise resulting from transfers to it from other entities of something of value to obtain or increase ownership interests in it.
What are distributions to owners?
Decreases in equity of a particular enterprise resulting from transfer to owners.
What is comprehensive income?
The change in equity of a business enterprise during a period from transactions and other events and circumstances from non owner sources. It includes all changes in equity during a period except those resulting from investments by owners and distribution to owners.
What are revenues?
Inflows or other enhancements of assets of an entity or settlements of its liabilities during a period from delivering or producing goods, rendering services, or other activities that constitute the entity’s ongoing major or central operations.
What are expenses?
Outflows or other using up of assets or incurrences of liabilities during a period from delivering or producing goods, rendering services, or other activities that constitute the entity’s ongoing major or central operations.
What are gains?
Increases in equity from peripheral or incidental transactions of an entity.
What are losses?
Represent decreases in equity arising from peripheral or incidental transactions of an entity.
What is the economic entity assumption?
The economic entity assumption presumes that economic events can be identified specifically with an economic entity.
What is the going concern assumption?
In the absence of information to the contrary, we anticipate that a business entity will continue to operate indefinitely. (i.e. financial statements of a company presume the business is a going concern)
What is the periodicity assumption?
The periodicity assumption allows the life of a company to be divided into artificial time periods to provide timely information.
What is the monetary unit assumption?
It states that financial statement elements should be measured in a particular monetary unit (in the United States, the U.S. dollar).
What is recognition?
Refers to the process of admitting information into financial statements.
What is measurement?
The process of associating numerical amounts with the elements.
What is disclosure?
The process of including additional pertinent information in the financial statements and accompanying notes.
What are the four recognition criteria?
- Definition: The item meets the definition of an element of financial statements.
- Measurability: The item has a relevant attribute measurable with sufficient reliability.
- Relevance: The information about it is capable of making a difference in user decisions.
- Reliability: The information is representationally faithful, verifiable, and neutral.
What is the realization principle?
Revenue should be recognized when the earnings process is virtually complete and collection is reasonably assured.
Both revenue recognition criteria usually are met at the __________.
point-of-sale (when the goods or services sold to the buyer are delivered)
What is the matching principle?
Expenses should be recognized in the period in which they produce revenues.
What are the 5 measurement attributes employed in GAAP?
- Historical cost
- Net realizable value
- Current cost
- Present (or discounted) value or future cash flows
- Fair value
What is historical cost?
Historical cost bases measurements on the amount given or received in the exchange transaction.
What is net realizable value?
Net realizable value bases measurements on the amount of cash into which the asset or liability will be converted in the ordinary course of business.
What is present value?
Present value bases measurement on future cash flows discounted for the time value of money.
What is fair value?
Fair value bases measurements on the price that would be received to sell assets or transfer liabilities in an orderly market transaction.
Fair value can be measured using:
- Market approaches
- Income approaches
- Cost approaches
GAAP gives a company the option to value financial assets and liabilities at _____________.
fair value
What is the full-disclosure principle?
It requires that any information useful to decision makers be provided in the financial statements, subject to the cost effectiveness constraint.
What are some examples of disclosures?
- Parenthetical amounts
- Notes to the financial statements
- Supplemental schedules and tables
What is the revenue/expense approach?
With the revenue/expense approach, recognition and measurement of revenues and expenses are emphasized.
What is the asset/liability approach?
With the asset/liability approach, recognition and measurement of assets and liabilities drives revenue and expense recognition.
Obligation to transfer cash or other resources as a result of a past transaction.
Liability
Dividends paid by a corporation to its shareholders.
Distribution to owners
Inflow of an asset from providing a good or service.
Revenue
The financial position of a company.
Assets, liabilities, and equity
Increase in equity during a period from non owner transactions.
Comprehensive income
Increase in equity from peripheral or incidental transaction.
Gain
Sale of an asset used in the operations of a business for less than the asset’s book value.
Loss
The owner’s residual interest in the assets of a company.
Equity
An item owned by the company representing probable future benefits.
Asset
Revenues plus gain less expenses and losses.
Net income
An owner’s contribution of cash to a corporation in exchange for ownership shares of stocks.
Investment by owner
Outflow of an asset related to the production of revenue.
Expense
Information is useful in predicting the future.
Predictive value
Pertinent to the decision at hand.
Relevance
Information is available prior to the decision.
Timeliness
Users understand the information in the context of the decision being made.
Understandability
Concerns the relevant size of an item and its effect on decisions.
Materiality
Important for making interfirm comparisons.
Comparability
Requires the consideration of the costs and value of information.
Cost effectiveness
Implies consensus among different measures.
Verifiability
Which component would allow a company to record the purchase of a $120 printer as an expense rather than capitalizing the printer as an asset?
Materiality only
Donald Kirk, former chairman of the FASB, once noted that “… there must be public confidence that the standard setting system is credible, that selection of board members is based on merit and not the influence of special interests …” Which characteristic is implicit in Mr. Kirk’s statement?
Neutrality
Allied Appliances Inc. chance its revenue recognition policies. Which characteristic is jeopardized by this change?
Consistency
National Bancorp, a publicly traded company, files quarterly and annual financial statements with the SEC. Which characteristic is relevant to the timing of these periodic filings?
Timeliness
In general, relevant information possesses which qualities?
- Predictive value
- Confirmatory value
- Materiality
When there is agreement between a measure or description and the phenomenon it purports to represent, information possesses which characteristic?
Faithful representation
A company should disclose information only if the perceived benefits of the disclosure exceed the costs of providing the information. Which constraint does this statement describe?
Cost effectiveness
The primary objective of financial reporting is to provide information:
Useful to capital providers
Statements of Financial Accounting Concepts issued by the FASB:
Identify the conceptual framework within which accounting standards are developed.
In general, revenue is recognized as earned when the earning process is virtually complete and:
There is reasonable certainty as to the collectibility of the asset to be received.
In depreciating the cost of an asset, accountants are most concerned with:
The matching principle
