F1 - Conceptual Framework and Financial Reporting Flashcards
Absorb EVERYTHING!
Which of the following assumptions means that money is the common denominator of economic activity and provides an appropriate basis for accounting measurement and analysis?
The monetary unit assumption means that money is the common denominator for economic activity and provides an appropriate basis for accounting measurement and analysis.
Define Replacement Cost:
the amount of cash or its equivalent that would be paid in order to replace an asset currently.
According to the FASB conceptual framework, an entity’s revenue may result from:
A decrease in liabilities from primary operations.
RULE: Revenues are inflows or enhancements of assets and/or settlements (decreases) in liabilities resulting from the entities ongoing major operations, not from “incidental” operations.
Current Ratio
Formula: Current Assets / Current Liabilities
Does the company have enough short term resources to fulfill their short term liabilities? The target is to acquire a ratio of at least 1.0 to show that the company has more assets than liabilities.
Quick Ratio
Formula: (Current Assets - Inventory) / Current Liabilities
Debt to Equity Ratio
Formula: Total Liabilities / Total Shareholders Equity
Deferred Revenue
Is considered money collected in advance for a product or service and is considered a liability.
CONCEPT: This transaction has created a “liability” to provide goods/services to the customer who has now paid in advance.
Gift cards/certificates are deferred revenue until they become used (and thus converted to revenue) or become expired.
Income Statement Structure
Sales - COGS = Gross income (profit) - Selling, general & admin expenses - Depreciation Equals operating income \+/- Misc. revenue/gains/expenses/losses (interest income, misc. expenses) = Income before tax - Income tax expense = Income from continuing operations \+/- Income from discontinued operations = Net income
Balance Sheet Structure
Assets = Liabilities + Shareholders’ Equity
The order of items is: Current Assets --> Cash, Inventory, Prepaid Expenses, Accounts Receivable, Short term investments. Long-term Assets Short-term Liabilities Long-term Liabilities Shareholders' Equity
Selling Expenses include:
Freight Out
Salaries and Commissions
Advertising
General & Administrative include:
Officers’ Salaries
Accounting and Legal
Insurance
Discontinued Operations
Appears below ‘Income from Continuing Operations’ on the Income statement and is presented net of tax.
The “results of operation” are presented on one line, and then the gain or loss “on the disposal of a business segment” is reported on a separate line.
(Ex.) Disposal of a component of a business.
Deferred Tax Liability
Items that will be taxable in the future create a deferred tax liability, because there is an amount that will increase taxable income in the future and therefore increased taxes.
Unearned Income (Deferred Revenue)
Occurs when a company receives money before the money is earned. This is also referred to as deferred revenue, customer deposits, unearned rent, etc. These accounts are recorded in the liability section of a Balance Sheet.
KEY: The transaction has created a “liability” to provide goods or services to the customer who has now paid in advance.
Franchise Accounting (Contracts)
A franchisor should report revenue from initial franchise fees when all performance obligations have been satisfied.
Service Contracts
Collections received for service contracts should be recorded as an increase to an unearned service revenue account.
Completed Contract Method
This method is utilized when the construction contract does not meet the criteria for recognizing revenue over time. Thus, revenue and gross profit are recognized when the contract is completed. Losses should be recognized in full the year they are discovered.
Formula: Gross Profit (Loss) = Contract price - Total costs
Percentage of Completion Method
Long-term construction contracts meet the criteria for recognizing revenue over time. This method can reasonably estimate profitability and proved a reliable measure of progress towards completion.
Formula: Step 1 - Compute gross profit of completed contract:
Contract Price - Estimated total Cost = Gross Profit
Step 2 - Compute the percentage of completion:
Total Cost to Date / Total Estimated Cost of Contract
Step 3 - Compute the Gross Profit Earned (profit to date):
Step 1 x Step 2 = PTD
Step 4 - Compute Gross Profit Earned for Current Year:
PTD at Current FYE - PTD at beginning of period = CY GP
Progress Billings (Liability in a Construction Contract)
A liability only exists when the progress billings exceed costs and estimated earnings (gross profit). Calculate current years Gross Profit through the % of completion formula then add the resulting value to the current years accumulated costs. If this value is greater than the progress billings amount, then a current asset is represented NOT a current liability.
Costs to Fulfill a Contract
(1. ) Costs that relate directly to a contract (such as direct labor, materials, allocated costs, and other costs that are explicitly chargeable to the customer per the contract).
(2. ) They generate or enhance resources of the entity.
(3. ) They are expected to be recovered.
Costs to be expensed include SG&A costs, wasted labor and material costs, and costs tied to satisfied performance obligations.
Held for Sale (Discontinued Operations)
The earliest period that a component of an entity can be recorded in the discontinued operation segment of the income statement is when the component meets the “held for sale” criteria as follows:
- Management commits to a plan to sell.
- The component is available for immediate sale in its present condition.
- An active program to locate a buyer has been initiated.
- The sale of the component is probable and the sale is expected to be completed within one year.
- The sale of the component is actively being marketed.
- It is unlikely that a significant change to the plan to sell will be made or that the plan will be withdrawn.
How should the effect of a change in accounting principle that is inseparable from the effect of a change in accounting estimate be reported?
Answer: As a component of income from continuing operations.
The reporting treatment for the overall effect is as a change in estimate. Thus, the effect is reported prospectively as a component of income from continuing operations.
Correction of an Error
Changes from non-GAAP method (Cash basis) of accounting to a GAAP method (accrual basis) of accounting is a specific correction of an error. Correction of an error from a prior period is reported as prior period adjustment to retained earnings.
Correction of an Error Without Comparative Financial Statements Present
Adjust (net of tax) the opening retained earnings of the earliest period presented.
