Chapter 2 Flashcards
What is conceptual framework?
Concepts that define the nature, function and limits of financial accounting and reporting.
Why do we need a conceptual framework?
We want to set accounting standards on a foundation of established concepts and assumptions.
What is the objective of conceptual framework?
Provide information about the reporting entity that is useful to present and potential equity investors, lenders and other creditors in their capacity as capital providers
What are the two groups or the second level of the conceptual pyramid?
Qualitative characteristics and elements
What are the 10 parts of the element section of the second level?
Assets, liabilities, equity, investments by owners, distribution by owners, comprehensive income, revenues, expenses, gains and losses.
What are the 2 subtopics in the qualitative characteristics side of the second level?
- Fundamental qualities
2. Enhancing qualities
What are the subsections of the fundamental qualities?
A. Relevance
- predictive value
- confirmatory value
- materiality
B. Faithful representation
- Completeness
- Neutrality
- Free from error
What are the subsections of the Enhancing qualities?
- Comparability
- Verfiability
- Timeliness
- Understandability
What are the assumptions of the conceptual framework?
- Economic Entity
- Going Concern
- Monetary Unity
- Periodicity
What are the principles of the conceptual framework?
- Measurement
- historical cost
- fair value - Revenue recognition
- Expense recognition
- Full disclosure
What are the constraints of the conceptual framework?
- Cost vs Benefit
2. Industry Practice
What are the 3 levels of fair value
level 1- (Most useful) assets you can measure
level 2- comparable
level 3- neither of the two
What are the 3 levels of the conceptual frame work.
Level 1-
Level 2-
Level 3-
Level 1- Objective - the “why”
Level 2- qualitative characteristics
Level 3- Assumptions, principles and constraints.
When did the statement of Financial Accounting Concepts (SFACs) starting 1978?
1978
What is an asset?
Something that gives probable future benefits obtained or controlled by an entity as a result of past transactions or events.
What are liabilities?
Something that causes probably future sacrifices of economic benefits arising from present obligations of an entity to transfer assets or provide services to other entities in the future as a result of past transactions or events.
What is equity?
Residual interest in the assets of an entity that remains after deducting its liabilities. Ina business enterprise, the equity is the ownership interest.
What is investment by Owners?
Increases in net assets (increase in equity) resulting from transfers to it from other entities of something of value to obtain or increase ownership interests (or equity) in it.
What is distribution to Owners?
Decreases in net assets (decrease in equity) resulting from transferring assets, rendering services, or incurring liabilities to owners.
What is comprehensive income?
Change in equity (net assets) of an entity during a period from transactions and other events and circumstances from non owner sources. In other words, all changes in equity during a period except those resulting from investments by owners and distributions to owners.
What are revenues?
Inflows or others enhancements of assets of an entity or settlement 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 carrying out other activities that constitute the entity’s ongoing major or central operations.
What are gains?
Increases in equity (net assets) from peripheral or incidental transactions of an entity and from all other transactions and other events and circumstances affecting the entity during a period except those that result from revenues or investments by owners.
What are losses?
Decreases in equity (net assets) from peripheral or incidental transactions of an entity and from all other transactions and other events and circumstances affecting the entity during a period except those that result from expenses and distribution to owners.
What do Revenues, Gains, and Investments by owners have in common?
All are increases in net assets
What do Expenses, Losses and Distribution to owners have in common?
All are decreases in net assets
What is relevance?
Information that is capable of making a difference in a decision
What is predictive value?
it can help users form expectations about the future
What is confirmatory value?
it can confirm or refute previously formed expectations
What is materiality?
omitting it or misstating it could influence decisions that users make.
What is Faithful representation?
amounts and descriptions match what really happened or existed
What is completeness?
we have provided all the necessary information
What is neutrality?
The information is unbiased
What is free from error?
The information is accurate
What is comparability?
ability to compare financial information
Between two different entities
What is consistency?
between two different accounting periods for the same entity (entity uses the same accounting methods from period to period)
What is verifiability?
The info can be independently confirmed.
What is timeliness?
the info is available before it loses its relevance
What is understandability?
reasonably informed users should be able to comprehend the information that is clearly classified and presented.
Quality information that permits users to identify similarities in and differences between two sets of economic phenomena
Comparability
Having information available to users before it loses its capacity to influence decisions
Timeliness
Information about an economic phenomenon that has value as an input to the processes used by capital providers to form their own expectations about the future.
Predictive Value
Absence of bias intended to attain a predetermined result or to induce a particular behavior
Nuetraility
Information that is capable of making a difference in the decisions of users in their capacity as capital providers
Relevance
Quality of information that assures users that information represents the economic phenomena that it purports to represents….
Faithful representation
Information about an economic phenomenon that corrects past or present expectations based on previous evaluations….
Confirmatory Value (confirming based on what you expect)
The extent to which information is accurate in representing the economic substance of a transaction
Free From Error
Includes all the info that is necessary for a faithful representation of the economic phenomena that it purports to represent…
Completeness
Quality of info that allows users to comprehend its meaning….
Understandability
What is recognition?
When we record transactions
What is the economic assumption?
- we must identify all transactions to a particular entity
- we assume the entity is separate and distinct from the owners and from other business entities
- entity concept does not preclude consolidated financial statements
What are the going concern assumptions?
- we assume the entity is an ongoing business witha long life
- rule of thumb is looking ahead at least one year or one operating cycle.
- going - concern assumption is the foundation for our definition of an asset
- management has the responsibility ( new ASU) to assess going concern
- We use conservatism when evaluation going concern. Not based on unfounded fears of what might happen in the future.
What are the Perodicity Assumptions?
- we divide time into measurable time periods to properly report the economic activities of the entity on its financial statements
- when determining the periods, entities balance precision vs timeliness
What is monetary assumption?
- AKA stable monetary unit concept or constant currency concept or stable $ concept
- money is the common denominator of economic activity so we measure transactions and events in units of money
- we also assume that the monetary unit will remain relatively stable.
Revenue Recognition Principle
Revenue is recognized when A) realized or realizable and B) earned.
What is the criteria for recognizing revenue?
- The performance obligation has been satisfied
- an exchange has occurred
- realization of the right to cash
Expense Principle ( matching principle)
Expenses must be matched to revenues recorded in the same period
what is direct matching?
an obvious match such as COGS for sales of inventory
What is indirect matching?
using a systematic and rational method for matching expenses to revenues over the periods benefited
What is full disclosure principle?
Financial statements must include enough information to influence judgement and decision making of an informed user.
Measurement Principle has two parts:
- Historical Cost
2. Fair Value
What is historical cost Principle?
The original acquisition cost of an asset or liability is a reliable basis of measurement and should be used.
What is fair value principle?
The current fair value of an asset or liability is more relevant because it reflect current cash equivalent.
SFAC no1
Objectives of financial reporting by business enterprises
-presents the goals and purposes of accounting
SFAC no2
Qualitative Characteristics of accounting information
-examines the characteristics that make accounting information useful
SFAC no3
Elements of Financial Statements of Business Enterprises
SFAC no5
Recognition and Measurement in financial statements of business enterprises
- 2 fundamental recognition criteria
- definition - must meet the definition of an element per SFAC 6
- measurability - must be measurable in currency
SFAC no6
Elements financial statements (REPLACEMENT OF SFAC 3)
expands to include not for profit organizations.
SFAC no7
Using cash flow information and present value in accounting measurements
- outlines how to use expected future cash flows and present value as a basis
SFAC no 8
Conceptual framework of financial reporting
SFAS NO 157 FAIR VALUE MEASUREMENT
2006
ASC 820-10
defines Fair value, establishes a measurement hierarchy, expands required disclosures in f/s
biggest advantage of fair value measurement
relevance (users want FV)
biggest disadvantage of fair value measurement
possible subjectivity
level 1 of FV heiracrchy
Most reliable
established price through an active market
level 2 of FV heirarchy
not active market
FV based on observable data, prices of comparable assets.
Level 3 of FV heirarchy
no observable data and FV uses its own assumptions
How is inventory measures on the balance sheet?
at each b/s date, we determine the market price of inventory. We report inventory at “Lower of cost or market” or “ lower of cost or net realizable value (LCNRV)
How is AR measured on the balance sheet?
each b/s date we report “net realizable value” of receivables (what we actually expect to receive for the asset in the future)
How are investments measured?
certain investments must be “Marked to market” (FV) at the end of each period
How are long term receivables and liabilities measured?
We consider the time value of money at an expected discount rate and value LT assets and liabilities based on the present value of expected future cash flows.
What is the cost restraint = cost vs benefit
the benefits that will be gained from providing certain accounting info should exceed the cost of providing that info
Conservatism contstraint
a. when using estimates, choose the value that will be least likely to
- overstate assets or revenues
- understate liabilities or expenses
b. delay recognition of gains (until revenue recognition standards have been met)
c. recognize losses sooner rather than later (immediately when expected and measurable)
target was involved in litigation over the last year. This litigation is disclosed in the financial statement
Full disclosure
target allocated the cost of its depreciable assets over the life it expects to receive revenue from these assets
expense recognition
target records the purchases of a new dell PC at its cash equivalent price
Historical cost
