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A311 > Exam 1 (Chapters 1-5) > Flashcards

Exam 1 (Chapters 1-5) Flashcards

1
Q

Balance sheet equation

A

Assets = liabilities + equity

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2
Q

Income statement equation

A

Revenue - expenses = net income

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3
Q

Retained earnings equation

A

Beg + NI - Dividends = Ending

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4
Q

Debit increases…

A

DEAD –> Debits, expenses, assets, dividends

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5
Q

Credit increases…

A

CLRS –> Liabilities, revenues, equity

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6
Q

Purposes of external financial accounting

A
  • Reducing information asymmetry
  • Evaluate future cash flows
  • Evaluate management (stewardship perspective)
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7
Q

What is accounting?

A

-Identification, measurement, and communication of financial information about economic entities to interested parties

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8
Q

Interest parties in financial accounting

A

Investors and creditors (external users)

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9
Q

Objective of financial accounting

A

Provide information that is USEFUL 1) equity investors and creditors 2) entity perspective 3) decision usefulness

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10
Q

Players in the accounting process

A
  • Management (Preparation, guided by GAAP)
  • Auditors (Verification, guided by GAAS)
  • Users (Analysis & Decisions, investors, analysts, and lenders)
  • SEC (Reporting & Enforcement, SEC Regulations)
  • FASB (Standard Setting, determines GAAP)
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11
Q

FASB

A
  • Private entity
  • Autonomous from SEC not governmental just oversight from SEC
  • No ability to enforce standards
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12
Q

SEC

A
  • Public entity
  • Has the power to oversee the whole process and has delegated some authority to FASB
  • Can decide if a company can be publicly traded or not
  • Faces alot of political pressure and lobbyists
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13
Q

Model used in the United States to develop GAAP

A

A mixed approach, GAAP is set by private sector bodies whose actions are heavily influenced by the government

  • Alot of conflict of interest
  • Takes a while to get anything done
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14
Q

Standard setting process

A

Standards in place to enhance comparability of financial statements, FASB has had primary responsibility since 1973

  • Topics identified and placed on board agenda
  • Research and analysis conducted, preliminary pro/con
  • Public hearing on proposed standard
  • Board evaluates research and public response
  • Evaluates responses, changes exposure draft
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15
Q

Due process

A

Used when considering a new standard

  • Operates in full view of the public
  • Responsive to needs off entire economic community
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16
Q

What is GAAP?

A
  • Principles to follow when collecting and presenting accounting information externally
  • Established by FASB with SEC oversight
  • Developed in the private sector but subject to political pressures
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17
Q

FASB Codification

A
  • New codification process to simplify GAAP
  • No more levels, organized into topics, subtopics, sections, and paragraphs
  • Help users gain a better understanding
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18
Q

IFRS

A
  • Published by IASB (based in London)
  • International principles growing world-wide
  • Focused on objectives and principles, less reliant on rules than GAAP
  • Since 2002 efforts have been underway to merge IFRS and GAAP
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19
Q

Benefits of IFRS

A
  • Reduced complexity, transparent, more comparability
  • Better comparisons with foreign companies (currently have to be completely different statements)
  • Global companies want to prepare statements with one set of standards (reduces cost)
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20
Q

Sarbanes-Oxley Act of 2002

A
  • Huge accounting scandal shook
  • Established the PCAOB which regulates financial audits
  • Increased auditor independence standards (conflict consulting/auditing services, 5 yr rule)
  • Requires CEO and CFO personal signature (more personally responsible) on financial statements
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21
Q

Challenges Facing Accounting

A
  • Accounting for soft assets (Human capital, brand value)
  • More forward-looking and timely information (no regulations on projections)
  • Ethics
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22
Q

How does accounting information benefit the capital allocation process?

A

Efficient allocation of capital resources requires knowing where it can be best put to use

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23
Q

Conceptual Framework

A
  • Coherence in rules and standards
  • Quick solutions to new and emerging problems through an existing basic theory
  • Increased user understanding and confidence
  • Enhanced comparability
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24
Q

SFAC No. 5

A

Recognition and Measurement in Financial Statements of Business Enterprises gives guidance on what information should be formally incorporated into financial statements

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25
Q

SFAC No, 6

A

Elements of Financial Statements replaces No. 3 and expands its scope to include non-profits

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26
Q

SFAC No. 8

A

The Obejctive of General Purpose Financial Reporting and Qualitative Characteristics of Useful Financial Information (replaces no 1 &2)

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27
Q

What are the Concepts intended to establish?

A

Th objectives and concepts for use in developing standards of financial accounting and reporting

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28
Q

First Level of Pyramid: Basic Objective

A

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

  • The “Why?” of Accounting
  • Systems that help us accomplish this objecctive
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29
Q

Second level: Basic elements & characteristics

A

Bridge between 1 & 3, contains the fundamental and enhancing characteristics and the basic elements of financial statements

30
Q

Qualitative Characteristics

A

Broader, theoretical to help distinguish more useful information

31
Q

Relevance

A

Must be capable of making a difference in a decision, ingredients are:

  • Predictive value
  • Confirmatory value (confirm prior expectation)
  • Materiality
32
Q

Faithful Representation

A

(Reliability), means that the numbers match what really happened. Ingredients are:

  • Completeness (nothing left out)
  • Neutrality (No bias in information)
  • Free from error (accuracy)
33
Q

Trade-off between Relevance and Faithful Representation

A

There exists a trade off between producing more reliable financial statements and the timeliness of them
More relevant, less reliable: Goodwill, intangible assets, Forecasts, allowance for doubtful accounts
Less relevant, more reliable: Land (historical cost and fair value accounting)

34
Q

Enhancing Qualities

A

Comparability - information reported in a similar way across companies, different from consistency which is similar treatment from one period to another (same firm)
Verifiability - independent measures obtain the same results (trust b/c you can replicate the numbers)
Timeliness - having information available to decision-makers before it loses its capacity to influence decisions
Understandability - quality of information that lets reasonably informed users see significance

35
Q

Elements

A

Assets, Liabilities, Equity, Investment by owners, distribution to owners, comprehensive income, revenues, expenses, gains & losses (outside of normal operations, incidental)
**All are Period of Time which reset each period except assets, liabilities, and equity which carry forward

36
Q

Third Level: Recognition and Measurement

A

The “how”, implementation
Consists of Assumptions, Principles, and Constraints
These are set forth in Concept No. 5

37
Q

Assumptions

A

Economic entity - separate managers from company, subsidiaries all part of one economic entity
Going concern - businesses will have a long enough life to justify the use of accruals and deferrals
Monetary unit - the monetary unit is most effective way to express changes in capital, no inflation assumption
Periodicity - activities of an enterprise can be divided into artificial time periods

38
Q

Principles

A

Measurement Principle - most commonly used are based on historical cost and fair value, FASB seems to think that fair value is more useful
Revenue Recognition Principle - Revenue is recognized in the period when performance obligation is satisfied, heart of difference between cash and accrual accounting
Expense Recognition Principle - let the expense follow the revenues (recognize in same period as revenue if tied tot he revenue or in period when expense is incurred)
Full disclosure principle - Financial statements should reveal any facts of sufficient importance to influence the judgment and decisions of an informed user (notes very important)

39
Q

Constraints

A

Cost constraint - the benefit derived from requiring accounting information should exceed the cost of providing it (costs 7.8 m on average)
Industry practices - removed from list but still a constraint

40
Q

Acctg Cycle Step 1: Journalizing

A

Include: reference date, debits written first, credits indented, total debits and credits must be equal

41
Q

Acctg Cycle Step 2: Posting to the Ledger

A

Transfer amounts in the journals to the general ledger, purpose is to summarize the amounts in each account (t accounts for each category)

42
Q

Acctg Cycle Step 3: Prepare Unadjusted Trial Balance

A

Lists all ledger accounts and their balances, the trial balance provides an initial check of the mechanical accuracy, have not yet accounted for expenses
**Does NOT necessarily mean it is free from error if debits and credits match up

43
Q

Acctg Cycle Step 4: Adjusting Entries

A

Adjusted entries are made at the end of the period to bring accounts up to date and ensure revenue/expense recognition

  • Never use cash in an adjusting entry
  • Adjusting entries affect at least one real account and one nominal account (balance at the end gets closed out)
  • Either accruals or deferrals
44
Q

Acctg Cycle Step 5: Adjusted Trial Balance

A

After journalizing and posting the adjusting entries, prepare a second trial balance called the Adjusted Trial Balance

45
Q

Acctg Cycle Step 6: Prepare Financial Statements

A

Prepare in this order: Income statement, statement of retained earnings, balance sheet, statement of cash flows
-Order is important because numbers flow form one statement to the next

46
Q

Acctg Cycle Step 7: Record and Post Closing Entries

A

Since nominal accounts accumulate data form one period at a time, they must be adjusted at the end of the period
Close out revenue accounts: because revenue is credit normal, you debit to close it, expense accounts debit income summary credit expense
Then, you must close out the income summary account to retained earnings
***If rev>exp, debit inc summary, credit RE; if rev<exp, debit RE and credit income summary
Finally, close out the dividend account (debit RE, credit dividends)

47
Q

Post-closing trial balance

A
  • Verify that nominal accounts have zero balances

- Verify that debits = credits

48
Q

Benefits of income statement

A

Evaluate past performance, predict future cash flows, accrual based

49
Q

Limitation of income statement

A

Items that cannot be reliably measured are omitted (changes in human capital)
Accounting methods affect income (FIFO v LIFO)
Estimation methods or judgments may distort income (bad debt expense, useful life of an asset)

50
Q

Earnings management

A
  • The planned timing of revenues, expenses, gains, and losses to smooth out bumps in earnings
  • Incentive to meet Wall Street expectations
  • Not necessarily illegal, but you are distorting (gray area)
  • Estimating earnings quality abnormal accruals
51
Q

Multi-step income statement

A

GAAP permits single or multi, multi separates operating and non-operating and may classify revenues and expenses by function
Research shows investors are more likely to read and consider multistep

52
Q

What number on the income statement is most important to investors?

A

Operating income, important predictor for future cash flows

53
Q

Unusual Gains or Losses

A

Atypical or infrequent but doesnt have to be both, generally report them in the other revenues

  • Do not disclose net of tax
  • i.e.: write-downs of inventory, restructuring costs, impairment of goodwill
54
Q

Items presented below “Income From Continuing Operations”

A
  • Order: Discontinued operations and extraordinary items
  • Must be separately disclosed
  • Disclosure is net of tax
  • After income from continuing operations
55
Q

Discontinued Operations

A
  • The results of operations and cash flows of a component of a company have been eliminated from the ongoing operations
  • No significant continuing involvement
  • Required to disclose facts and circumstances leading to the disposal
56
Q

Extraordinary Items

A

Both unusual and infrequent, FASB has eliminated these items from the IS

57
Q

Changes in Principle

A
  • The result of adopting an accounting method that is different from one previously used (LIFO to FIFO)
  • Violates consistency
  • Restate comparative years presented in current year financial statements
  • Adjust beginning retained earnings of earliest comparative year presented for cumulative effect
  • DO have to change prior financial statements
58
Q

Correction of errors

A

Could be intentional or unintentional

Treated like a change in principle (retroactive adjustments and cumulative adjustments to beginning retained earnings)

59
Q

Change in estimates

A

Handled differently, these are normal recurring adjustments that result from periodic revisions in estimates
NOT made retroactively , only account for change in the current period
i.e.–> changes in estimated collectability of receivables

60
Q

Earnings per share

A

Calculated as: Net income - Preferred Dividends / Avg shares outstanding, tells us amt of earnings available to give to common shareholders

  • dividends to common shareholders not deducted from eps because preferred are like debt
  • Separate eps for everything below the continuing operations line
61
Q

Statement of Retained Earnings

A

Summarizes changes in the balance of Retained Earnings from the beginning to the end of the period

  • Includes net income and dividends
  • Prior period adjustments, reported NET OF TAX
62
Q

Balance Sheet Elements

A

Summarize what the company owns, who has claims to what the company owns at any point in time
Assets - Probable economic benefits obtained ro controlled by the entity as a result of past transactions
Liabilities - probably future economic sacrifices of economic benefits arising from present obligations of the entity to transfer assets to other entities in the future as a result of past events
Equity - Residual claim on the assets of the company (whatever is left over after satisfying liabilities)

63
Q

Usefulness of the balance sheet

A

Used to evaluate risk, evaluate capital structure andd predict future cash flows
Used to assess:
-Liquidity: amount of time until an asset is converted to cash or a liability is paid
-Solvency - the ability to pay debts as they mature
-Financial flexibility - Ability to alter amounts and timing of cash flows to respond to unexpected

64
Q

Limitations of the Balance Sheet

A

Many assets and liabilities are reported at historical cost and may lack relevance
Subjective judgments and estimates determine many values
Items might be omitted that cannot be measured objectively

65
Q

Current assets

A 
Resources the firm expects to be turned to cash or consumed withing a year or the operating cycle
Presented in order of liquidity
1) Cash and cash equivalents
2) Short-term investments
3) Receivables
4) Inventory
5) Prepaid assets
66
Q

Short term investments

A

1) Held-to-maturity: debt, amortized cost, current or non-current (can never be equity)
2) Trading: Debt or equity, fair value, current (unrealized gains or losses recognized here in NI)
3) Available-for-sale: catch-all for anything else, can be debt or equity, fair value, current or non-current

67
Q

Non-current assets

A

Will be converted to cash at some date beyond the operating cycle
Still in order of liquidity (long-term investments,PPE, Intangible Assets)

68
Q

Intangible assets

A
  • Limited-life intangibles (patents, copyrights)

- Indefinite intangibles (goodwill)

69
Q

Current liabilities

A
  • Reasonably expected to be liquidated within one year

- Reported in the order they will be paid or liquidated

70
Q

Long-term liabilities

A

Obligations that are reasonably expected to be liquidated at some date beyond one year

71
Q

Stockholder’s equity

A

Capital stock
-Preferred stock and common stock
-Carried at the par or stated value
Additional Paid-in Capital
-The excess of amounts paid in over the par or stated value
Retained Earnings
-The undistributed earnings of the company over entire life
Other
-Accumulated OCI (other comprehensive income, on BS not IS), treasury stock (buying back shares), minority interest (if another company owns some portion)

72
Q

Additional Information Reported

A

There are normally 4 types of information that are supplemental to account titles and balance sheet amounts

  • Contingencies (uncertain events)
  • Accounting policies (usually Note 1)
  • Contractual situations (debt terms)
  • Fair values (primarily for financial instruments)

A311 (3 decks)

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