CHAPTER 2 Flashcards
What are the classified statements of financial position?
Assets, liabilities, and shareholders’ equity
Current vs non-current assets
Current assets - assets expected to be converted to cash, sold, or used in the business within on year of the financial statement date or one operating cycle (whichever one is longer); listed in order of liquidity.
Non-current - sometimes known as “long-term assets”, all other assets; i.e. PP&E, land, long-term investments, etc.
What is depreciation?
Allocation of the expense of the cost of PP&E over their estimated useful lives; sometimes known as amortization.
Difference between the cost of an asset and its accumulated depreciation is known as the carrying amount.
Current vs non-current liabilities
Current - obligations to be settled within one year of the financial statement date or the operating cycle; i.e. accounts payable, deferred revenue, current portion of long-term debt.
Non-current - obligations expected to be settles after one year; i.e. bank loan, lease, pension, deferred liabilities.
Comparisons useful for financial analyses (3)
Intracompany comparisons - cover two or more periods of the same company
Intercompany comparisons - between the company and a competitor
Industry average comparisons - based on averages for particular industries
What is a liquidity ratio?
A measure of a company’s ability to pay it’s maturing obligations and to meet it’s expected needs for cash.
Measured by a current ratio, which is current assets divided by current liabilities, or working capital, which is current assets minus current liabilities.
Higher is generally better.
What is a solvency ratio?
A measure of a company’s ability to survive over a long period of time; higher percentage represents higher risk that debts cannot be repaid.
Measured by debt-to-total assets ratio, which is total liabilities divided by total assets.
Lower is generally better.
What is a profitability ratio?
A measure of the income or operating success of a company for a given period of time, usually, a year.
Measured by basic earnings per share ratio, which is income available to shareholders divided by the average number of common shares, or by price-earnings ratio, which is market price per share divided by basic earnings per share.
Higher is generally better.
What is the conceptual framework for financial reporting?
It is the foundation for the accrual basis of accounting; it guides decisions about what to present in financial statements, alternative ways of reporting economic events, and appropriate ways of communicating this information.
What are the fundamental qualitative characteristics of financial reporting? (2)
- Relevance - information may have predictive and/or confirmatory value; information has relevance if it makes a difference in user’s decisions. Information has to have materiality to be relevant.
- Materiality - if the information was to be omitted, would it influence the decisions of the users? - Faithful representation - information should reflect economic reality; it has to be complete, neutral, and free from error.
What are the enhancing qualitative characteristics of financial reporting? (4)
- Comparability - information has comparability when different companies use the same accounting principles and consistently apply them each year; can be compared to other companies or the same company at different points of time.
- Verifiability - information can be verified by an independent accountant. Information can be reproduced by a third party if they have access to the same facts and assumptions
- Timeliness - information should be available before it looses its value & usefulness in decision making.
- Understandability - information must be classified, characterized, and presented clearly and concisely; should be understandable by someone with reasonable knowledge of business and economic activity.
Define cost constraint
Cost constraint arises when the cost of production financial reporting outweighs the value and benefits it holds to those using the report.
This is why the benefits of financial reporting should always outweigh and justify the cost if providing those reports.
Define going concern assumption
An assumption that the business will continue operating in the foreseeable future.
Businesses should continue operating long enough to meet all of its commitments, obligations, and objectives.
What are the six elements of financial statements?
- Assets
- Liabilities
- Equity
- Revenue
- Expenses
- Income
How are the elements of financial statements measured, according to GAAP? (2)
- Historical cost - assets and liabilities being continuously recorded at their original cost.
- Fair value - assets and liabilities being reported as their current value.
Define separate entity assumption
Transactions and activities conducted by a business are separate from those conducted by its owners.
Define unit of measurement assumption
Accounting information should be reported in the domestic currency of the business.
Define periodicity assumption
Accounting information can be separated into artificial periods of time, such as months, quarters, or years.
