conceptual framework Flashcards
Fair Value Measurement Approach
- Identify the asset/liability
- Det. principal/most advantageous mkt(highest & best use)
- Determine the valuation premise without considering the cost of transaction(in use or exchange)
- det. appropriate valuation technique(market, income, cost approach)
- Obtain inputs for valuation(level 1, 2, 3)
- Calculate the fair value of asset.
Primary Qualitative Characteristics SFAC -8
In order to be useful, information must be both Relevance and Faithful Representation(reliability
A)Relevance(Roger is PC)
Predictive value
Confirmatory Value(feedback value)
or both
Material
B)Faithful Representation(FENCe)
Free from Error
Neutral(w/o) Bias)
CompletenessEnhancing Qualitative Characteristics
CUT like a V(enhance the usefulness but not required) Comparability(consistency) Understandability Timeliness Verifiability
Constraint
cost/benefits
Definition of Public entities(FASB)
1)submit financial statements to SEC
2)Are regulated under the 1934 Securities Exchange act
3)Issuing securities that are traded or listed on exchanged
4) Required to apply GAAP and has securities that are not restricted to transfer.
5)They use General purpose frameworks which include
GAAP
IFRS
Mostly apply accrual basis of accounting
Comprehensive income(GAAP)
Net income + DENT
Derivative cash flow hedges
Excess adjustment of Pension PBO and FV of plan asset at year end
Net unrealized gains or losses on “available for sales” securities
Translation adjustments for foreign currency
Summary of Logic of Accounting Principles
5) Accounting Principles
4) Recognition/Measurement
3) F/S elements
2) Qualitative Characteristic - “useful”
1) Objective of financial Reporting
Objectives of financial reporting(SFAC 8)
1) provide useful information to user
2) economic resources and claim against entity(B/S)
3) changes in economics resources and claims(I/S)
4) Accrual accounting
5) Cash flow
6) Changes in economics resources and claims not resulting from financial performance(e.g issue stock)
10 Keys elements of Financial Statement
1) Assets
2) Liabilities
3) Equity or Net Assets
4) Investment by owners
5) Distribution to Owners
6) Comprehensive income
7) Revenue(inflow from normal business operation)
8) Expenses(outflow from normal business operation)
9) Gains(incidental transactions)
10) Losses(incidental transactions)
Definition of Assets(GAAP)
1) Economic resources
2) Probable future benefits
3) One can obtain the benefits
4) Transaction has already occurred.
Financial Reporting Framework
It may have general purpose framework or special purpose frameworks and it should include
Recognition Criteria - what and when appear on F/S
Measurement Criteria - the amt on F/S
Presentation Criteria - where it appear on F/S
Disclosure Criteria - what information and how much information must be provided to users
Nonpublic entities
They may choose either General Purpose framework or Special purpose framework.
Special Purpose frameworks
referred to Other Comprehensive Basis of Accounting(OCBOA); mostly apply accrual basis of accounting
Defined as “A definite set of Criteria, other than accounting principles generally accepted in US or IFRS, having substantial support underlying the preparation of FS prepared pursuant to that basis.”
Types of special purpose frameworks
1) Cash Basis /modified cash basis
2) Tax basis
3) Contractual basis
4) Rgulatory basis
Cash Basis
cash received or cash disbursement regardless of when they are earned or incurred.
Modified Cash basis
Hybrid between cash and accrual where assets can be capitalized and taxes and inventory could be accrued.
Tax Basis
Tax basis can be cash or accrual - basis
it looks at revenue and expense based on what is tax deductible or what is not.
Contractual Basis
contractual obligation based on whatever method of accounting mentioned in the contract.
regulatory Basis
one required by a governmental or regulatory agency
Accrual basis of accounting
revenues are recognized in the periods in which they are earned regardless of when they are received and expenses are recognized in the periods in which they are incurred regardless of when they are paid.
Private company Council(PCC)
Purpose
1) it exempts or simplified accounting procedures to reduce the cost w/o diminishing the value of information
2) only apply to non-public entity
Private company council(PCC)
How to apply
1) The entity elect it and disclose it in its summary of Significant accounting policies.
2) In the period of adoption, the entity will indicate it adoption and state the primary difference between it and previous requirement.
3) It also need to disclose in subsequent periods and still prepare F/S in accordance of GAAP .
Full set of financial Statement
Statement of Position(Balance Sheet)
Statement of Earnings Financial & Comprehensive Income(Income Statement)
Statement of Cash Flows
Statement of Changes in Owners Equity(Statement of Investments by and distribution to Owners)
Physical capital maintenance concept
Only recognize an event when an asset is sold or a liability is settled
measures the effects of price changes in nominal or constant dollars(fixed assets)
Financial capital maintenance concept
recognize an event as a change in the value of asset or liability occurs.
Liability(GAAP)
an economic obligation in which one needs to use or transfer an asset, it cant be avoided; the transaction has already occurred.
Accounting Rules and Concepts
- Consistency
- Conservatism
- Cost/Benefits
- Matching(Equipment-depreciation)
- Allocation(Intangible asset)
- Full Disclosure - footnotes
- Recognition - book
- Realization - sold
When to recognize the F/S elements and how to measure it
- meet the definition of an element(asset, liability)
- Element is capable of being measured in monetary terms
- The term is relevant and faithful representation(useful)
Monetary Terms
- Historical cost
- Replacement cost
- Fair Market value
- Net realizable value
- Present value.
Fair market value definition
ASC 820, 1)The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction(not a forced transaction) between market participants at the measurement date.
2) ASC 820 does not allow nor require assets or liabilities be reported at fair value unless required.
Net Realizable value
amount expected to be converted to (e.g A/R)
What items required to be reported at fair value?
1) investments in marketable debt or equity securities that are classified as either trading securities or available for sales(mark to market)
2) assets acquired and liabilities assumed in a business combination but not for the adjustment in a subsequent periods
3) Impairment losses for receivable, goodwill and intangibles and depreciable assets and amortizable intangible.
4) All derivatives.
5) ASC 825 Financial instruments allows an entity to elect to report some or all of its financial assets and liabilities at their fair value.
ASC825 do not qualify following items for the fair value election:
1) Pension plan, post- retirement, and other post employment benefits
2) Financial instruments that are component of equity
3) share based payment and stock options
ASC825 qualify following items for the fair value election
1) Available for sales securities
2) Held to maturities securities
3) Investment under equity method
4) Firm commitment involving financial instruments: currency forwards.
How to elect the qualify items under ASC825?
1) an entity may elect an fair value option for any qualifying financial instruments individually
2) election date: An election may only be made when asset or liabilities are acquired
3) once elected, fair value option is permanent and may only be discontinued on a subsequent election date and unrealized G/L are reported in income .
definition of financial instruments
it is defined as cash, evidence of an ownership interest in an entity or a contract that both
a. Imposes on one entity a contractual obligation that either:
1. to deliver cash or another financial instrument to a second entity
2. to exchange other financial instruments on potentially unfavorable terms with the second entity
b. conveys to that second entity a contractual right either
1. to receive cash or another financial instrument from the first entity
2. to exchange other financial instruments on potentially unfavorable terms with the first entity.
define fair value of following iterms
a) cash
b) an investment in marketable securities
c) account receivable
d) inventory
a) cash = face amount
b) marketable securities = market value
c) account receivable = net realizable value
d) inventory = replacement cost
Define market participants
- independent of entity
- reasonably knowledgeable about the asset or liability
- In a position to acquire the asset or assume the liability
- willing to acquire the asset or assume the liability
define exchange price
what I am going to get from selling it
define in use
measure the value by using that assets
Principal market
trade with greatest volume
most advantages market
maximize the price
Market approach
looking at the market transactions that involves same or comparable assets or liabilities(stock)
Income approach
Present value technique
cost approach
Cost to replace it
Level 1 input
most reliable; observable transaction data in an active market for identical asset or liabilities(stock quote)
Level 2 input
involves the data from active market transaction but either:
@no active market transaction
b) transaction relate to similar but not identical assets or liabilities.
level 3 input
unobservable data; based on management judgement
Fair value disclosure requirements
1) disclose the extent to which fair value is used to measure recognized assets and liabilities
2) the inputs used to develop the measurement
3) valuation technique(MIC)
3) the effect of certain measurement on earning for the period.(B/S or IS)
How does expected cash flows approach differ from traditional cash flow approach?
- Traditional approach - try to look at the probability of something happening and determine how much should the valuation be; use the most likely amount
- Expected cash flow - take a weighted average of the money we expect to come in.
what are the factors of cash flow need to be considered?
1) Risk - probability of get paid or recd
2) Timing
3) Interest rate
Under Accrual Accounting, when are revenue and gains are recognized?
1) Earned - earning process is complete
2) Realizable(realized) - collect cash or a claim to cash
Based on Revenue Recognition, when is a revenue recognized?
1) A binding Arrangement exists
2) Services rendered or delivery has occurred
3) Fixed or determinable prices exists
4) Collection is reasonably assured.
When should I recognize expenses under accrual accounting?
1) cause and effect: I sold inventory, therefore I would expense the cost of good sold as I sell the inventory.(cost of good sold)(product cost)
2) Systematic and rational allocation: bought an equipment and match it systematically and rationally over the next 10 years.(depreciation)
3) Immediate recognition:(SG&A)(period cost)
When do expenses or losses recognize?
Recognize it as incurred.
*Economic benefit is used up(consumed) or assets lose future benefits(as incurred)
What are the four risks and uncertainties areas of disclosure?
1) Nature of operations
2) Use of Estimates
3) Certain significant estimates
4) current vulnerability associated with certain concentrations.
Describe nature of operation
description of how the entity generates revenue such as major products and services and principle markets served.
Describe use of estimate
use in the preparation of financial statements in accordance with GAAP and other financial reporting frameworks
Certain Significant estimates
Certain significant estimate talk about probable loss. If it is reasonably possible, you need to disclose it. If it is remote, you dont. If it is probable and estimable, you need to disclose and accrue or book it.
Current vulnerability due to certain concentrations
occur when an entity does not diversify.
FASB Accounting Standards Codification(ASC)
was to create one cohesive set of accounting standards and ASC reorganized thousands of GAAP pronouncements into 90 accounting topics
GAAP hierarchy consist of two levels( what are they)
1) one authoritive(In FASB ASC)
2) non - authoritive(non FASB ASC)
Statements on Financial Accounting Concepts(SFAC)
It was issued by FASB periodically to represent the ideas of FASB as to the theoretical framework which it believes should guide financial accounting and reporting.
Emerging issues Task Force(EITF)
focus on how to account for new and unusual financial transactions that have the potential for creating differing financial reporting practices.
Footnotes to the financial statements include
1) Summary of significant accounting principles - describe the significant accounting principle and methods used in F/S.
2) Summary of significant assumptions: describe the assumptions used to estimate future amount for prospective financial statements.
3) Other notes to the financial statements -such as contingent liabilities, contractual obligations, amount coming due for bonds and leases in next 5 years, significant changes in account balances.
