FAR 1 (Framework, Overview, and Statements) Flashcards
01 - FASB and Standard Setting
Q - The Wheat Committee was involved in the Formation of the FASB.
True.
01 - FASB and Standard Setting
Q - The primary objective of financial statements is to provide information useful in assessing stewardship.
False.
01 - FASB and Standard Setting
Q - “Economic consequences” is a concept used by the FASB to gain acceptance of its proposed standards.
False.
01 - FASB and Standard Setting
Define - “GAAP”
Generally Accepted Accounting Principles: The rules of financial reporting for business enterprises. Also called “accounting standards.”
01 - FASB and Standard Setting
Q - What does GAAP address?
Recognition - a recognized item is recorded in an account and affects the financial statements
Measurement - the dollar amount assigned to an item
Disclosure - many unrecognized amounts are reported in the footnotes to complete the portrayal of financial position and performance
01 - FASB and Standard Setting
Define - “FASB”
Financial Accounting Standards Board: The current standard setting body of the United States. Has 7 full time members, do not need to be CPAs
01 - FASB and Standard Setting
Define - “SEC”
Securities and Exchange Commission: The federal agency that administers securities laws. These laws affect firms that issue debt and equity securities to the public. These firms must file audited financial statements.
01 - FASB and Standard Setting
Define - “AICPA”
American Institute of Certified Public Accountants: The national professional organization for practicing CPAs.
01 - FASB and Standard Setting
Define - “CAP”, “ARB”, “APB”, “FAF”, “FASAC”
CAP: Committee on Accounting Procedure
ARB: Accounting Research Bulletins
APB: Accounting Principles Board
01 - FASB and Standard Setting
Define - “FAF”
Financial Accounting Foundation: Appoints the members of the FASB and advisory councils, ensures FASB funding, and oversees FASB
01 - FASB and Standard Setting
Define - “FASAC”
Financial Accounting Standards Advisory Council: Provides guidance on major policy issues, project priorities, and the formation of task forces
01 - FASB and Standard Setting
FASB’s Process for Issuing an Accounting Standard
- Consideration of adding projects to its agenda.
- Conduct topical research and issue a Discussion Memorandum
- Hold public hearings on the topic
- Evaluate research and comments and issue an Exposure Draft
- Review additional comments and revise ED, if necessary
- Finalize new guidance (majority vote for approval)
- Issue an Accounting Standards Update
01 - FASB and Standard Setting
Define - “EITF”
Emerging Issues Task Force: Acts as a “filter” for the FASB. Consider emerging issues and accelerate the process of establishing rulings
01 - FASB and Standard Setting
Q - In reference to proposed accounting standards, the term “negative economic consequences” includes:
The inability to raise capital.
02 - GAAP and Accrual Accounting
Authoritative GAAP
FASB Codification - sole source for nongovernmental entities, except for SEC guidance
02 - GAAP and Accrual Accounting
Nonauthoritative GAAP
Accountign and financial reporting practices not included in the Codification
02 - GAAP and Accrual Accounting
Accrual Basis
Revenues are recognized when earned, regardless of the period of cash collection.
Expenses are recognized when incurred, regardless of the period of cash payment.
02 - GAAP and Accrual Accounting
Accruals/Deferrals
Accruals: Service provided/received before payment/receipt
Deferrals: Service performed/used after payment/receipt
02 - GAAP and Accrual Accounting
Q - A deferred revenue is a liability account
True.
02 - GAAP and Accrual Accounting
General Rule to Convert from Cash Basis Revenue to Accrual Basis Revenue
Add beginning liability balances and subtract ending liability balances
Subtract beginning asset balances and add ending asset balances
02 - GAAP and Accrual Accounting
General Rule to Convert from Cash Basis Expenses to Accrual Basis Expenses
Subtract beginning liability balances and add ending liability balances (accrued expenses)
Add beginning asset balances and subtract ending asset balances (prepaid expenses)
02 - GAAP and Accrual Accounting
FOB Shipping Point
Title passes at the time the goods are shipped, so a company can recognize revenue from a transaction at the time of shipment
02 - GAAP and Accrual Accounting
Matching
Companies should match expenses to the period in which the benefits are received
02 - GAAP and Accrual Accounting
Right of Return
If a company engages in a sale of goods with a right of return (the buyer may return the merchandise), the company should delay recognition until the right of return has expired
02 - GAAP and Accrual Accounting
Relevance
Relevance is a primary qualitative characteristic. To be relevant, information about an item must have feedback value or predictive value (or both) for users and must be timely
02 - GAAP and Accrual Accounting
Predictive Value
The quality of information that helps users to increase the likelihood of correctly forecasting the outcome of past or present events
03 - Financial Statements
Income Statement
Reports accrual-based performance over a period of time. Dated as fiscal year ended.
03 - Financial Statements
Statement of Comprehensive Income
Reports non-owner changes to equity over a period of time. Dated as fiscal year ended.
03 - Financial Statements
Balance Sheet (Statement of Financial Position)
Reports economic resources and obligations. Dated as of a specific date.
03 - Financial Statements
Statement of Stockholders’ Equity
Reports the changes in owners’ equity over a period of time. Dated as fiscal year ended.
03 - Financial Statements
Statement of Cash Flows
Reports changes in cash over a period of time. Dated as fiscal year ended.
03 - Financial Statements
Categories of Cash Flows
Operating: Related to income statement transactions
Investing: Related to long-term assets and investments
Financing: Related to liabilities and owners’ equity
05 - Objectives, Qualitative Characteristics
Primary Qualitative Characteristics of Financial Information
Relevance: Predictive value, confirmatory value, and materiality (Does it RELATE to my decision?)
Faithful Representation: Completeness, neutrality, and free from error (Can I DEPEND on it?)
05 - Objectives, Qualitative Characteristics
Enhancing Qualitative Characteristics of Financial Information
Comparability, verifiability, timeliness, and understandability
05 - Objectives, Qualitative Characteristics
Q - Interim financial statements can be described as emphasizing:
Timeliness over faithful representation.
Interim reports generally reflect estimates. The objective is to provide reasonable information in a timely fashion, rather than exact information.
05 - Objectives, Qualitative Characteristics
Overall Objective of financial reporting
Decision Usefulness
05 - Objectives, Qualitative Characteristics
What is a predictive value?
Information that assists capital providers in forming expectations about future events.
05 - Objectives, Qualitative Characteristics
What is a confirmatory value?
Information that confirms or changes past (or present) expectations based on previous evaluations.
05 - Objectives, Qualitative Characteristics
What is completeness of information?
Information that includes all necessary data to be faithfully representative.
05 - Objectives, Qualitative Characteristics
What does it mean for information to be neutral?
Information that is free from any bias.
05 - Objectives, Qualitative Characteristics
What does it mean to be free from error?
Information that has no omissions or errors.
05 - Objectives, Qualitative Characteristics
What is comparability?
The quality of information that enables users to identify similarities and differences between sets of information.
05 - Objectives, Qualitative Characteristics
What is verifiability?
Different knowledgeable and independent observers could reach similar conclusions based on the information.
05 - Objectives, Qualitative Characteristics
What is timeliness?
Information that is received in time to make a difference to the decision maker.
05 - Objectives, Qualitative Characteristics
What is understandability?
Information that a user can comprehend within the decision context at hand. Users are assumed to have a reasonable understanding of business and accounting.
06 - Assumptions, Accounting Principles
Entity Assumption
There is a separate accounting entity for each business organization.
06 - Assumptions, Accounting Principles
Going Concern Assumption
In the absence of information to the contrary, a business will have a definite life. This supports the historical cost principle for many assets.
06 - Assumptions, Accounting Principles
Unit-of-Measure Assumption
Assets, liabilities, equities, revenues, expenses, gains, losses, and cash flows are measured in terms of the monetary unit of the country in which the business is operated. Values are not adjusted for inflation.
Capital Maintenance - Financial capital is maintained so long as dividends do not exceed earnings and earnings are not negative.
06 - Assumptions, Accounting Principles
Time Period Assumption
The indefinite life of a business is broken into smaller time frames for evaluation purposes and reporting purposes.
06 - Assumptions, Accounting Principles
Historical Cost Principle
The cash equivalent amount of an asset or liability at the time of origination. This is the market value of the item on the date of acquisition.
06 - Assumptions, Accounting Principles
Net Realizable Value
Used to approximate liquidation value or selling price. It is the net value to be received after the costs of sale are deducted from the current market value.
06 - Assumptions, Accounting Principles
Current Replacement Cost
How much you would have to pay to replace an asset. Represents current market value from the buyer’s perspective.
06 - Assumptions, Accounting Principles
Current Market Value
Also known as fair value. It is the price that would be received to sell an asset or settle a liability in an orderly transaction between market participants at the measurement date.
06 - Assumptions, Accounting Principles
Amortized Cost
Historical cost less the accumulated amortization or depreciation of an asset.
06 - Assumptions, Accounting Principles
Net Present Value
Determined from discounting the expected future cash flows.
06 - Assumptions, Accounting Principles
Revenue Recognition Principle - What is revenue?
Increases in assets or extinguishment of liabilities stemming from the delivery of goods or the provision of services.
06 - Assumptions, Accounting Principles
Revenue Recognition Principle - When to recognize revenue?
Revenues are recognized when they are realized and earned.
Realization occurs when:
- Goods or services have been provided
- Collectibility of cash is assured
- Expenses of providing goods and services can be determined
06 - Assumptions, Accounting Principles
Revenue Recognition Principle - How to measure revenue?
At the cash equivalent amount of the good or service provided.
06 - Assumptions, Accounting Principles
Matching Principle
Addresses when to recognize expenses.
- Only when expenditures help to produce revenues
- Some expenses are allocated based on the time period of benefit provided
- Other expenses are recognized in the period incurred when there is no determinable relationship between expenditures and revenues
06 - Assumptions, Accounting Principles
Full Disclosure Principle
Financial statements should present all information needed by an informed reader to make an economic decision.
06 - Assumptions, Accounting Principles
Assumptions come Entirely from your GUT
Entity
Going Concern
Unit-of-Measurement
Time Period
07 - Constraints and Present Value
Cost Constraints on GAAP
Limit recognition and disclosure if the cost of providing the information exceeds its benefit. However, firms cannot omit disclosures if they are material and mandated.
07 - Constraints and Present Value
Conservatism
The reporting of less optimistic amounts under conditions of uncertainty or when GAAP provides a choice from various recognition or measurement methods.
- Avoid inflating expectations of capital providers
- Conservatism conflicts with neutrality
07 - Constraints and Present Value
Full set of Financial Statements
Balance Sheet, Income Statement, Statement of Comprehensive Income, Statement of Cash Flows, and Statement of Owners’ Equity.
07 - Constraints and Present Value
Recognition and Measurement Criteria
Definition: Definition of a financial statement element is met
Measurability: There is an attribute to be measured
Relevance: Information is capable of influencing decisions
Faithful Representation: Information is complete, neutral, and free of material errors
07 - Constraints and Present Value
Elements of Financial Statements - Assets
Resources that have probable future benefits to the firm, are controlled by management, and result from past transactions
07 - Constraints and Present Value
Elements of Financial Statements - Liabilities
Probably future sacrifices of economic benefits arising from present obligations of an entity to transfer assets or provide services to other entities as a result of past transactions or events
07 - Constraints and Present Value
Elements of Financial Statements - Equity
Residual interest in the firm’s assets. Primarily comprised of past investor contributions and retained earnings.
07 - Constraints and Present Value
Elements of Financial Statements - Investments by Owners
Increases in net assets of an entity from transfers to it by existing owners or parties seeking ownership interest
07 - Constraints and Present Value
Elements of Financial Statements - Distributions to Owners
Decreases in net assets of an entity from the transfer of assets, provision of services, or incurrence of liabilities by the enterprise to owners
07 - Constraints and Present Value
Elements of Financial Statements - Comprehensive Income
Accounting income plus certain holding gains and losses and other items.
07 - Constraints and Present Value
Elements of Financial Statements - Revenues
Increases in assets or settlements of liabilities of an entity by providing goods or services
07 - Constraints and Present Value
Elements of Financial Statements - Expenses
Decreases in assets or incurrences of liabilities of an entity by providing goods or services.
Provide a benefit to the firm.
07 - Constraints and Present Value
Elements of Financial Statements - Gains
Increases in equity or net assets from peripheral or incidental transactions
07 - Constraints and Present Value
Elements of Financial Statements - Losses
Decreases in equity or net assets from peripheral or incidental transactions.
Provide no benefit to the firm.
08 - Fair Value Framework: Introduction and Definition
Define - “Fair Value”
The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date
08 - Fair Value Framework: Introduction and Definition
Elements of Fair Value
Market-based measurement.
Determined for a particular asset, liability or equity item:
- Single item
- Group of related items
Determination should consider attributes of the specific item being measured:
- Condition, location, restrictions of use
- FV not based on buyer’s unique perspective
08 - Fair Value Framework: Introduction and Definition
Define - “Orderly transaction”
Assumed to occur at the measurement date
Assumed to occur under current market conditions
Not assumed to occur in forced liquidation or distressed sale
08 - Fair Value Framework: Introduction and Definition
Define - “Principle Market”
The market available to the entity with the greatest volume and level of activity for the item
08 - Fair Value Framework: Introduction and Definition
Define - “Most Advantageous Market”
The market available to the entity that maximizes selling price or minimizes transfer price
08 - Fair Value Framework: Introduction and Definition
Define - “Market Participants”
Buyers and sellers that are:
- Independent of the reporting entity
- Acting in their best economic interest
- Knowledgeable of the item being measured and the transaction type
- Able and willing to enter a transaction, but not compelled to do so
09 - Recognition and Measurement
Define - “Entry price”
The amount paid to acquire an asset or received to assume a liability
09 - Recognition and Measurement
Define - “Exit price”
The amount received to sell an asset or paid to transfer a liability
09 - Recognition and Measurement
Entry Price does not equal Exit Price - Accounting treatment?
A gain or loss is recognized in income
09 - Recognition and Measurement
Approaches for Fair Value Determination
Market Approach: Uses prices generated by real market transactions for identical or similar items
Income Approach: Discounts future amounts to a current present value
Cost Approach: Uses current amount required to replace the service value of an existing asset
09 - Recognition and Measurement
Fair Value Option Election Dates
- When the item is first recognized
- When an eligible firm commitment is established
- When the accounting treatment of an investment in another entity changes
09 - Recognition and Measurement
Accounting at Eligible Election Date
Determine the Carrying Value (CV).
Determine the Fair Value (FV).
Determine the difference between CV and FV.
Recognize difference as:
- Write item up or down
- Recognize gain or loss in current income
09 - Recognition and Measurement
Accounting after Election
At each subsequent reporting date:
- Adjust item to new fair value
- Recognize difference as:
- Write item up or down
- Recognize gain or loss in current income
DR: Asset
CR: Unrealized Gain - Fair Value Option
10 - Inputs and Hierarchy
Define - “Inputs”
The various assumptions that market participants would use in determining fair value
10 - Inputs and Hierarchy
Types of Inputs
Observable: Developed based on market data obtained from sources independent of the reporting entity
Unobservable: Reflect the reporting entity’s own assumptions used in pricing; developed based on the best information available in the circumstances
10 - Inputs and Hierarchy
Fair Value Measurement Inputs Hierarchy: Level 1
Unadjusted quoted prices at measurement date in active markets for identical items.
- Highest level
- Most reliable evidence of FV
- Liquidity discount: permitted
- Control premium: not permitted
- Blockage discount: not permitted
10 - Inputs and Hierarchy
Fair Value Measurement Inputs Hierarchy: Level 2
Inputs observable, either directly or indirectly, that do not meet all conditions for Level 1.
- Quoted prices in active markets for similar items
- Quoted prices in markets that are not active for identical items
- Observable inputs other than quoted market prices that are relevant to an item being valued
- Inputs derived from or corroborated by observable market data using correlation or other means
10 - Inputs and Hierarchy
Fair Value Measurement Inputs Hierarchy: Level 3
Unobservable inputs for the item being valued.
- Lowest level, least desirable inputs
- May use reporting firm’s internal data
- Based on assumptions or inferences that market participants would make
11 - Disclosure Requirements: Fair Value Framework
What do disclosure requirements depend upon?
Whether fair value is used:
- On a recurring basis
- On a nonrecurring basis: only when certain conditions or situations occur
12 - IASB and Structure
Organization Structure: Monitoring Board
Responsible for appointing and approving the appointment of the Trustees of the IFRS Foundation.
Provides a formal link between the Trustees and public authorities.
12 - IASB and Structure
Organization Structure: IFRS Foundation
Formerly the International Accounting Standards Committee Foundation (IASCF).
The Trustees appoint the members of the IASB, IFRS
Advisory Council, and the IFRS Interpretations Committee.
Responsible for overseeing, reviewing effectiveness, and financing the IASB.
The 22 Trustees are paid and serve terms of three years (renewable once).
12 - IASB and Structure
Organization Structure: IASB
Responsible for promoting the IFRSs, including those for SMEs (small and medium-sized entities), and for approving Interpretations of IFRSs.
The 16 members are paid and serve terms of up to five years (renewable once) and must sever all employment relationships with current employers, including rights to return.
12 - IASB and Structure
Organization Structure: IFRS Interpretations Committee
Similar to the FASB’s Emerging Issues Task Force.
The committee’s pronouncements are reviewed by the IASB before they are issued.
Responsible for reviewing issues arising in the context of IFRSs and issuing Interpretations of those issues.
The 14 members are not paid (though their travel expenses are met by the IFRS Foundation) and serve renewable terms of three years.
12 - IASB and Structure
Organization Structure: IFRS Advisory Council
Advise the IASB on priorities and the views of interested organizations on major projects, as well as the benefits and costs of proposed standards.
There are 30 or more members who are appointed by the Trustees.
13 - IASB Accounting Standards
IFRS Hierarchy
- Requirements in IFRSs dealing with similar and related issues
- The definitions, recognition criteria, and measurement concepts for assets, liabilities, income, and expenses in the Framework
- If no guidance exists, pronouncements of other standard-setting bodies using a similar conceptual framework, other accounting literature, and accepted industry practices
13 - IASB Accounting Standards
Development of IFRS
- Item added to agenda
- Conduct research and issue a Discussion Paper
- Prepare and issue an Exposure Draft
- Review public comments and discussions
- Modify the ED, if necessary
- Finalize and issue the IFRS
14 - IASB Framework
Elements of Financial Statements
Assets Liabilities Equity Income Expenses
14 - IASB Framework
Define - “Asset”
A resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity
14 - IASB Framework
Define - “Liability”
A present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying future benefits
14 - IASB Framework
Define - “Equity”
The residual interest in the asset after subtracting liabilities
14 - IASB Framework
Define - “Income”
Increases in economic benefits deriving from increases in assets or decreases in liabilities that result in increases in equity.
Income may be realized or unrealized and includes both revenues and gains. However, gains are usually reported separately from revenues
14 - IASB Framework
Define - “Expenses”
Decreases in economic benefits deriving from decreases in assets or increases in liabilities that result in decreases in equity.
Expenses may be realized or unrealized and also includes losses. However, losses are usually reported separately from expenses
14 - IASB Framework
Assumptions
- The financial statements are prepared on the accrual basis
- The entity is a going concern
15 - SEC Role and Standard-Setting Process
Purpose of the SEC
The SEC enforces compliance of GAAP for all publicly traded companies and compliance of IFRS for foreign registrants.
Has the authority to set standards, but has delegated that task to the FASB (private sector)
15 - SEC Role and Standard-Setting Process
XBRL
Extensible Business Reporting Language.
XBRL tags accounting data into a taxonomy to ease the access to the data.
15 - SEC Role and Standard-Setting Process
Organizational Structure of the SEC
Has five commissioners appointed by the President.
Has four divisions.
- Division of Corporate Finance: oversees compliance and examines all filings.
- Division of Enforcement: Completes an investigation and takes appropriate actions when there is a violation of a securities law.
- Division of Trading and Markets: Oversees the secondary markets, exchanges, brokers, and dealers.
- Division of Investment Management: Oversees investments advisers and investment companies.
Office of the Chief Accountant - Houses technical expertise on principles, standards, and requirements. Issues position papers for the SEC to consider. Is the link between the SEC and the profession.
15 - SEC Role and Standard-Setting Process
Laws Administered by the SEC
Securities Act of 1933 Securities Act of 1934 Public Utility Holding Company Act of 1935 Trust Indenture Act of 1939 Investment Company Act of 1940 Investment Advisors' Act of 1940 Securities Investor Protection Act of 1970 Sarbanes-Oxley Act of 2002
15 - SEC Role and Standard-Setting Process
SEC Pronouncements
Financial Reporting Releases (FRR): Highest ranking authoritative source of accounting for public companies.
Staff Accounting Bulletins (SAB): Provide the SEC’s current position on technical issues
Accounting and Auditing Enforcement Releases (AAER): Report the enforcement actions taken against accountants, brokers, or others
16 - SEC Reporting Requirements
Regulation S-X
Governs the form and content of financial statements and financial statement disclosures.
Income Statement, Balance Sheet, Changes in Shareholders’ Equity, Statement of Cash Flows, Footnotes, and Qualification of Accountants (independence rules).
16 - SEC Reporting Requirements
Regulation S-K
Governs the form and content of non-financial statement disclosures.
Description of the business, description of stockholder matters, MD&A, changes in and disagreements with accountants, and information on directors and management.
16 - SEC Reporting Requirements
Securities Act of 1933
Requires publicly traded firms offering securities for sale to the public in the primary and secondary markets to file a registration statement, and to provide each investor with a proxy statement before each shareholders’ meeting.
16 - SEC Reporting Requirements
Securities Act of 1934
Regulates the trading of securities after they are issued and provides the requirements for periodic reporting and disclosures.
16 - SEC Reporting Requirements
Form S-1
Basic registration form for new securities.
Part 1 - Prospectus that describes the issuing company, business operations and risks, financial statements, and expected use of proceeds.
Part 2 - Information about the cost of issuing and distributing the security, detailed information about the directors and officers, and additional financial statement schedules.
16 - SEC Reporting Requirements
Financial Statements for IPO
- 2 years of Balance Sheets
- 3 years of Income Statements, Statements of Cash Flows, and Statements of Owners’ Equity
16 - SEC Reporting Requirements
Required Filings
- Form 10-K - Annual filing
- Form 10-Q - Quarterly filing
- Form 8-K - Significant events
- Proxy Statement - Management request to vote through proxy for shareholders at meetings
16 - SEC Reporting Requirements
Corporate Governance
Foreign Corrupt Practices Act of 1977
- Prohibits bribes of goreign governmental or political officials for the purpose of securing contracts or business
Sarbanes Oxley Act of 2002 (SOX)
- Enhance corporate governance and mitigate financial accounting abuses
- Established the Public Company Accounting Oversight Board (PCAOB)
- Limited auditors services
- Increased reporting on internal controls
- Increased penalties for fraud and white collar crime
17 - Balance Sheet 1
Balance Sheet Facts
- Reports the entity’s financial position at a point in time
- Most reported account balances do not represent current market value
- Provides information useful in assessing the entity’s financial strengths and weaknesses
- Classified Balance Sheet: distinguishes current and noncurrent assets and liabilities to help users assess liquidity
- Does not report all assets of the firm, only the assets acquired through a transaction
17 - Balance Sheet 1
Measurement Bases
Historical Cost: Some accounts are measured and reported at a fixed, unchanging historical amount.
Depreciated, Amortized, or Depleted Historical Cost: The remaining portion of a fixed, unchanging historical amount.
Market Value: Also called “fair value,” is the selling price for assets and amount currently required to retire a liability.
Net Realizable Value: The amount the firm expects to receive from the sale or collection of the item.
Present Value: The measure of current sacrifice when extinguishing the debt at the balance sheet date. The present value of a future cash flow is its discounted value.
17 - Balance Sheet 1
Current Asset (CA)
An asset expected to be realized in cash or to be consumed or sold during the normal operating cycle, or within one year of the balance sheet date, whichever is longer.
Cash, cash equivalents, ST investments, A/R, inventory, prepaids.
17 - Balance Sheet 1
Current Liability (CL)
A liability expected to be extinguished through the use of current assets or by the incurrence of other current liabilities.
A/P, accrued liabilities, unearned revenue, income tax payable, notes payable, current portion of LT debt.
17 - Balance Sheet 1
Noncurrent Assets and Liabilities (NCA and NCL)
Defined as assets and liabilities that are not current. GAAP only explicitly defines current items.
NCA - LT investments, property, plant, equipment, intangibles, “other” assets.
NCL - Notes payable, bonds payable, lease liabilities, pension liabilities, post-retirement health care liabilities, deferred taxes.
17 - Balance Sheet 1
Ratios for liquidity
Current Ratio = CA/CL (usually expect a minimum value of 2)
Quick or Acid-Test Ratio = (Cash +/- Short-term Investments +/- AR) / CL (should be at least 1)
17 - Balance Sheet 1
Goodwill
The excess of the purchase price paid for another business over the market value of its net assets.
Only recognized on the balance sheet of a purchaser when a firm is purchased.
Internally generated goodwill is expensed.
17 - Balance Sheet 1
Owners’ Equity
Contributed Capital - Common stock, preferred stock, additional paid in capital, treasury stock (contra)
Retained Earnings - Net income, less dividends
17 - Balance Sheet 1
Contra Accounts
Has a balance opposite that of the associated account in terms of debit and credit.
17 - Balance Sheet 1
Adjunct Accounts
Has a balance that is the same as that of the associated account in terms of debit and credit.
17 - Balance Sheet 1
Valuation Accounts
Used to increase or decrease the book value of an item to a measure of current value.
Not all contra or adjunct accounts are valuation accounts, but all valuation accounts are contras or adjuncts.
17 - Balance Sheet 1
Firm Valuation
Total OE (Net Assets) - Found on balance sheet
Market Value of Net Identifiable Assets - Amount of cash that would remain after selling all identifiable assets and paying off all liabilities. Also called the liquidation value.
Total Value of the Firm - The total value of the firm’s outstanding stock (Market Capitalization)
18 - Balance Sheet 2
Control Accounts
Report the aggregate balance of several subsidiary accounts.
18 - Balance Sheet 2
Accounting Cycle
The periodic process leading to the preparation of financial statements.
- Analyze relevant source documents and record journal entries in a journal.
- Post the information from the journal to the accounts in the ledger, on a periodic basis.
- Record adjusting journal entries at the end of the accounting period. These journal entries are also posted to the accounts.
- Prepare trial balances.
- Prepare the income statement, balance sheet, and statement of cash flows.
- Close the temporary account balances and transfer the net income amount to retained earnings.
18 - Balance Sheet 2
Special Journals
Facilitate the review and control of similar transactions.
Simplify the recording of journal entries because each recording affects the same accounts each time.
The number of postings is reduced because only the sum of the changes need to be posted.
Separation of duties for improved internal control is fostered.
18 - Balance Sheet 2
Differences Between U.S. GAAP and IFRS
On the Statement of Financial Position, IFRS specifies a minimum listing of accounts that must be presented.
IFRS requires more detailed note disclosures.
IFRS financial statements are cleaner in appearance with no U.S. GAAP parenthetical disclosures.
IFRS does not require a specific formatting of information. Many countries use their customary formats, including presenting the items in reverse order and from less liquid to more liquid. This emphasizes the long-run perspective.
U.S. GAAP discourages the use of the term “reserve” which is a category found within equity and liabilities in IFRS.
18 - Balance Sheet 2
IFRS Definition of Current Assets
Must meet one of the following criteria:
- It is expected to be realized in, or is intended for sale or consumption in, the entity’s normal operating cycle
- It is primarily held for the purpose of being traded
- It is expected to be realized within 12 months after the reporting period
- It is cash or a cash equivalent unless it is restricted from being exchanged or used to settle a liability for at least 12 months after the reporting period
- All other assets are noncurrent
18 - Balance Sheet 2
IFRS Definition of Current Liabilities
Must meet one of the following criteria:
- It is expected to be settled in the entity’s normal operating cycle
- It is held primarily for the purpose of being traded
- It is due to be settled within 12 months after the reporting period
- The entity does not have an unconditional right to defer settlement of the liability for at least 12 months after the reporting period
- All other liabilities are noncurrent
19 - Income Statement 1
Revenues
Increases in net assets or settlements of liabilities by providing goods or services.
Related to the primary business operations
19 - Income Statement 1
Expenses
Decreases in net assets or incurred liabilities through the provision of goods or services.
Related to the primary business of operations.
Provide benefit to the firm.
19 - Income Statement 1
Gains
Increases in equity or net assets from peripheral or incidental transactions.
19 - Income Statement 1
Losses
Decreases in equity or net assets from peripheral or incidental transactions.
Do not provide value or benefit to the firm.
19 - Income Statement 1
All-Inclusive Income Statement
Currently used under U.S. GAAP. Essentially all revenues, expenses, gains, and losses are shown on the income statement and included in the net income allocation.
19 - Income Statement 1
Exceptions to the All-Inclusive Income Statement
Prior Period Adjustments - shown on the Statement of Retained Earnings and are the correction of accounting errors affecting income of prior years.
Other Comprehensive Income (OCI) Items
- Foreign currency translation adjustments
- Unrealized holding gains and losses on securities available for sale
- Pension and other post-retirement benefit plan cost adjustments
- Certain deferred derivative gains and losses
Retrospective changes in accounting principles affecting income - treated as direct adjustments to retained earnings.
19 - Income Statement 1
Current Operating Performance Income Statement
Limit the income statement to normal, recurring items.
Many other items would run through owners’ equity.
19 - Income Statement 1
Accounting Income
Revenues - expenses + gains - losses.
Recorded transactions, events, and adjustments.
For many assets and liabilities, changes in market value are not recognized until substantiated by a transaction between willing parties.
19 - Income Statement 1
Economic Income
The change in the net worth of a business enterprise during an accounting period.
The net worth of a business enterprise is described as the fair market value of net assets
Net income for the period would include all changes in FMV of assets and liabilities during the period.
Mkt. Value of NA at 1/1 + NI + Owner Investments - Dividends and Stock Repurchases = Mkt. Value at 12/31
19 - Income Statement 1
Structure - Top Portion
Includes routinely occurring items and other items that are appropriately included in income from continuing operations.
GAAP is very loose with regard to presentation.
Income from continuing operations includes all income items other than those in the bottom portion
19 - Income Statement 1
Structure - Bottom Portion
Items that are specifically defined by GAAP as being unrelated to continuing operations.
Not representative of the firm’s ability to generate income and are unique items that will not be repeated.
GAAP is very specific about measurement and presentation.
Two major components:
- Discontinued operations - major components of an entity that are either sold or planned to be sold
- Extraordinary items - Both unusual and infrequent
19 - Income Statement 1
Intraperiod Tax Allocation
Allocation of the total tax consequence for that year among income from continuing operations and:
- Discontinued operations (IS)
- Extraordinary items (IS)
- Other comprehensive income items (AOCI)
- Adjustment for retroactive accounting principle changes (Statement of RE)
- Prior period adjustments (Statement of RE)
Requires that cumulative effects of accounting principle changes be reported net of tax
19 - Income Statement 1
Interperiod Tax Allocation
Does not require that cumulative effects of accounting principle changes be reported net of tax
20 - Income Statement 2
Single Step Income Statement
Presentation is largely based on a single comparison.
Total revenues and gains are compared with total expenses and losses.
20 - Income Statement 2
Multiple Step Income Statement
Presentation of income from continuing operations that includes multiple comparisons of revenues, expenses, gains, and losses.
The reader is provided with the operating income, as well as the incidental or peripheral gains and losses.
20 - Income Statement 2
IFRS - Single Statement of Comprehensive Income
Presents the components of both profit or loss and other comprehensive income within a single statement leading to total comprehensive income as the bottom line.
Profit or loss is shown as a subtotal within the statement.
20 - Income Statement 2
IFRS - Two Statements
A separate income statement is presented along with a statement of comprehensive income.
20 - Income Statement 2
Differences between U.S. GAAP and IFRS
IFRS requires minimum line items to be disclosed on the face of the income statement.
U.S. GAAP only specifies certain things on the bottom portion of the income statement. IFRS mandates that additional line items, headings, or subtotals be disclosed separately.
IFRS does NOT allow the reporting of income statement items as extraordinary.
Terminology differences.
U.S. GAAP allows alternative measures of performance to be reported on the face of the income statement.
20 - Income Statement 2
IFRS Expense Classifications
IFRS requires firms to analyze expenses either by:
- Function
- Nature of the expense
If a firm uses the functional system, the firm must disclose the additional information on the nature of expenses.
20 - Income Statement 2
IFRS - Reporting by Function of Expenses
Focuses on the activity to which the expense relates.
More prevalent in IFRS reports that reporting by nature.
20 - Income Statement 2
IFRS - Reporting by Nature of Expenses
Focuses on the type of expense.
21 - Statement of Comprehensive Income
Comprehensive Income
The sum of net income and other comprehensive income.
CI = NI + OCI
Other Comprehensive Income items are not currently recognized as income and are recorded directly as increases or decreases in owners’ equity.
21 - Statement of Comprehensive Income
Single Statement of Comprehensive Income Approach
Presents the components of profit or loss within a single statement leading to net income as a subtotal.
Displaying the other comprehensive income items leads to total comprehensive income.
21 - Statement of Comprehensive Income
Two Statements Approach
A separate income statement is presented immediately before the statement of comprehensive income.
The net income amount resulting from the first statement is used as the beginning amount for the second statement, which then reports the other comprehensive income items.
21 - Statement of Comprehensive Income
Purpose of Reporting Comprehensive Income
To report the net change in equity (other than from transactions with owners) in a single amount and to provide a more complete picture of the total earnings of the firm for a period.
21 - Statement of Comprehensive Income
Other Comprehensive Income (OCI) Items
The following items are typically reported net of tax, but can also be reported on a pretax basis with the net aggregate income tax effect reported as a separate item:
- Unrealized gains and losses on securities available for sale
- Unrecognized pension and post-retirement benefit cost and gains
- Foreign currency translation adjustments are changes in the value of foreign currency and accounts measured in foreign currency
- Certain deferred gains and losses from derivatives
21 - Statement of Comprehensive Income
Items NOT Included in Comprehensive Income
- Retrospective effects of changes in accounting principle
- Prior period adjustments
These are reported as adjustments to retained earnings.
21 - Statement of Comprehensive Income
Accumulated Other Comprehensive Income (AOCI)
The amount carried over form the previous period, and then either increased or decreased during the current period.
Owners’ equity account.
21 - Statement of Comprehensive Income
Differences Between U.S. GAAP and IFRS
U.S. GAAP and IFRS presentation requirements are the same as of January 2012.
International accounting standards allow firms to revalue plant assets and intangibles to fair value. A revaluation surplus can never be reclassified to affect net income.
22 - Statement of Changes in Equity Under U.S. GAAP
Background
How firms report the changes in their owners’ equity accounts for the period.
In addition to this, firms must also report the changes in the number of shares of equity securities.
Statement is dated for a period.
22 - Statement of Changes in Equity Under U.S. GAAP
Vertical Format
Each OE account is reported in a separate column of a spreadsheet-type document.
20 - Income Statement 2
Transportation In vs. Transportation Out
Transportation In - Inventory related account that is used to close Cost of Goods Sold
Transportation Out - A selling cost, not a product cost. It is closed along with other expenses and revenues.
22 - Statement of Changes in Equity Under U.S. GAAP
Horizontal Format
Each account is explained from beginning balance to ending balance in one set of rows, one account schedule on top of another.
22 - Statement of Changes in Equity Under U.S. GAAP
Comparative Statements
Report three years.
Vertical format - Each year is stacked on top of the other. Vertical within each year and horizontal across years.
Horizontal format - Each year is represented in side by side columns. Horizontal within each year and vertical across years.
22 - Statement of Changes in Equity Under U.S. GAAP
Differences between U.S. GAAP and IFRS
- Required statement of IFRS, US firms have other reporting options
- International statements must report:
- Total comprehensive income with amounts separation of non-owner changes
- Effect of retrospective application (change in accounting policy) or retrospective restatement (correction of an error)
- Reconciliation of the beginning and ending carrying amounts of each component of equity - Amounts of dividends can be presented in the statement or in the notes
- Under IFRS, entities may use different titles
22 - Statement of Changes in Equity Under U.S. GAAP
Background
Provides the beginning balance, changes during the year, and ending balance for the following accounts:
- Stock
- APIC
- Retained Earnings
- Treasury Stock
- AOCI
22 - Statement of Changes in Equity Under U.S. GAAP
Presentation
Can be presented in the footnotes, supplemental schedules, or as a separate statement.
23 - Sources and Uses of Cash
Purpose of the Statement of Cash Flows
To provide information about the cash receipts and cash payments for an entity to help investors, creditors, and others assess:
- Past ability to generate and control cash inflows/outflows
- Probable future ability to generate cash flows sufficient to meet future obligations and pay dividends
- Likely need for external borrowing
Also provides information about investing and financing activities that do not involve cash inflows/outflows
23 - Sources and Uses of Cash
Cash Equivalents
Defined as
- Short-term, highly liquid investments
- Readily convertible to known amounts of cash
- Sufficiently close to maturity so that the risk of changes in value due to changes in interest rate is insignificant
Investments are considered cash equivalents only when their original maturity is 3 months or less
A change in policy for designating cash equivalents is a change in accounting principle
23 - Sources and Uses of Cash
Information Provided on SCF
Operating Activities Investing Activities Financing Activities Foreign Currency Translation Reconciliation Non-cash Investing and Financing Activities
23 - Sources and Uses of Cash
Direct Method - Operating Activities
Reports the actual operating cash flows in the operating section.
Reports the reconciliation in a separate schedule.
23 - Sources and Uses of Cash
Indirect Method - Operating Activities
Reports the reconciliation of net income and net operating cash flow in the operating section.
Most commonly used method.
24 - Operating, Investing, and Financing Activities
Cash Flows from Operating Activities
Relates to items that enter into the determination of net income and can be positive or negative.
Inflows: From customers, dividends, and interest
Outflows: To suppliers, to EE’s, interest, and income taxes
Direct approach: presents operating cash flow by classes of sources and uses
Indirect approach: presents operating cash flow by adjusting accrual net income to operating cash flow (reconciliation of net income)
Interest paid and received and dividends received are all operating cash flows, but dividends paid is a financing cash flow.
24 - Operating, Investing, and Financing Activities
Cash Flows from Investing Activities
Relates to “investment in” and disposal of noncash assets and can be positive or negative.
Inflows: Sale of LT assets, collection of loan principal, disposal of debt and equity securities (HTM & AFS), and sale of other productive assets
Outflows: Purchase of LT assets, lending, investment in debt and equity securities (HTM & AFS), and purchase of other productive assets
Presented in the same manner, regardless of whether the direct or indirect approach is used.
24 - Operating, Investing, and Financing Activities
Cash Flows from Financing Activities
Relates to how the entity is financed and can be positive or negative.
Inflows: Sale of own stock, proceeds from borrowing
Outflows: Repurchase of own stock (treasury), paying back lenders (principle only), payment of dividends
Presented in the same manner, regardless of whether the direct or indirect approach is used.
24 - Operating, Investing, and Financing Activities
Effects on Cash of Foreign Currency Translation
Reports the effect on the change in cash that results from changes in currency exchange rates.
Shown as part of the reconciliation of the change in cash and cash equivalents during the period.
Transactions that occur during the period should be converted using:
- The exchange rate in effect at the date of each transaction, or
- The average exchange rate for the period
Balances held in foreign currency at period end should be converted to dollars using the spot (current( exchange rate at the date of the BS.
Presented in the same manner, regardless of whether the direct or indirect approach is used.
24 - Operating, Investing, and Financing Activities
Reconciliation of Change in Cash
Reconciles the net effect of operating, investing, financing cash flows and the net effect of foreign currency translation with the difference between cash at the beginning and end of the period.
Net Increase (or Decrease) in cash and equivalents during X2 + Beginning cash and equivalents on 1/1/X2 = Ending cash and equivalents on 12/31/X2
Net change in cash and equivalents is the amount that must be exactly explained by the operating, investing, financing, and foreign currency categories.
24 - Operating, Investing, and Financing Activities
Noncash Investing and Financing Activities
Reports the significant investing and financing activities that occur, at least in part, without affecting cash.
Presented in related disclosures (schedule or footnote)
25 - Operating Cash Flows: Indirect Method
Direct and Indirect Methods - Similarities/Differences
Similarities:
- Cash Flows from Investing Activities
- Cash Flows from Financing Activities
- Effect of Foreign Currency Translation
- Reconciliation with Cash Change
- Non-Cash Investing and Financing
Differences:
- Components of Cash Flows from Operating Activities (subtotal is the same)
- Reconcile Cash Flows from Operating Activities with Net Income (D - supporting schedule, I - in body of stmt)
- Payments for Interest (D - in body of stmt, I - additional disclosure)
- Payments for Income Tax (D - in body of stmt, I - additional disclosure
25 - Operating Cash Flows: Indirect Method
Direct Method of Presenting Cash Flow from Operating Activities
Each item in the income statement is adjusted from an accrual basis to cash basis.
25 - Operating Cash Flows: Indirect Method
Direct Method Disclosure of Operating Cash Flows
Separate cash flows for the following elements of operations:
- Collections from customers
- Collections for interest and dividends (on loans made and investments)
- Collections form other operating sources
- Payments to employees
- Payments to suppliers
- Payments for operating expenses
- Payments for interest (on debt)
- Payments for income taxes
- Payments for other operating uses
25 - Operating Cash Flows: Indirect Method
Direct Method - Collection from Customers
Revenues may include accruals (revenue earned, but not collected) and exclude deferrals (cash collected, but revenue not earned)
Revenue + A/R decrease - A/R increase + Unearned Rev increase - Unearned Rev decrease
25 - Operating Cash Flows: Indirect Method
Direct Method - Cash Payments to Suppliers
Cost of Goods Sold may include changes in inventory and/or changes in accounts payable.
C/G/S + Inventory increase - Inventory decrease + A/P decrease - A/P increase
25 - Operating Cash Flows: Indirect Method
Direct Method - Cash Payments for Operating Expenses
Expenses may include accruals (expenses incurred but not paid) and/or deferrals (cash paid but expense not incurred).
Note: this can apply to all types of expenses.
Operating Exp + Prepaid Exp increase - Prepaid Exp decrease + Exp Payable decrease - Exp Payable increase
25 - Operating Cash Flows: Indirect Method
Direct Method - Reconciliation of “Net Cash Flow from Operating Activities” with Net Income
Shows the adjustments to Net Income necessary to arrive at Cash Flow from Operating Activities
The schedule is identical to the “Cash Flow from Operating Activities” section using the Indirect Method
25 - Operating Cash Flows: Indirect Method
Indirect Method of Presenting Cash Flow from Operating Activities
Begins with Net Income (accrual basis) and adjusts for items that entered into computing Net Income, but did not affect cash by the same amount.
Net Income does not reflect net cash flow from operations
- Add back non-cash charges (reductions) included in NI
- Subtract out non-cash credits (increases) included in NI
25 - Operating Cash Flows: Indirect Method
Indirect Method Disclosure of Operating Cash Flows - Add Back
Items that we deducted in getting net income, but did not cause cash to be used.
- Depreciation Expense
- Amortization Expense
- Depletion Expense
- Losses (from sale of assets, etc.)
- Loss under equity method of accounting for investments
- Amortization of Premium on Bond Investment
- Amortization of Discount on Bond Payable
- Decreases in current assets (A/R, inventory, ppd’s, etc.)
- Increases in current liabilities (A/P, deferred taxes, etc.)
- Increase in Unearned Revenue
25 - Operating Cash Flows: Indirect Method
Indirect Method Disclosure of Operating Cash Flows - Subtract Out
Items were added in getting net income, but did not cause cash to be received.
- Gains (from sale of assets, etc.)
- Amortization of Discount on Bond Investment
- Amortization of Premium on Bond Payable
- Undistributed income under equity method of accounting for investments
- Increases in current assets
- Decreases in current liabilities
- Decrease in Unearned Revenue
25 - Operating Cash Flows: Indirect Method
Indirect Method - Depreciation/Amortization/Depletion Expenses
Non-cash expenses that must be added back to net income by the amount recognized as an expense
If amount is not provided, it can be derived form the balance sheet and related information, if given.
Calculation of the unknown expenses can be done using a schedule or a t-account approach.
25 - Operating Cash Flows: Indirect Method
Indirect Method - Losses/Gains
Non-cash deductions or additions that must be added back to or subtracted from net income by the amount recognized as a loss or gain.
If amount is not provided, it can be derived from the balance sheet and related information, if given.
25 - Operating Cash Flows: Indirect Method
Indirect Method - Equity Method Adjustments
Used when an investor must recognize their share of the investee’s net income or net loss in the period it it reported by the investee, whether or not any dividends are paid by the investee.
The investor has increased (with revenue) or decreased (with loss) net income without any related cash flow.
Only cash dividends received from the investee cause a cash flow.
25 - Operating Cash Flows: Indirect Method
Indirect Method - Amortization of Bond Premiums/Discounts
Amortization of a premium or discount will enter into net income (through interest income or interest expense), but will not generate or use cash.
25 - Operating Cash Flows: Indirect Method
Indirect Method - Amortization of Premium on Bond Investment
When bonds are purchased for more than maturity value, a premium results.
The debit to interest income reduces the amount of net income, but does not use cash.
The amount of amortization should be added back to net income.
**If bonds had been acquired at a discount, the resulting amortization would have to be subtracted from net income.
25 - Operating Cash Flows: Indirect Method
Indirect Method - Amortization of Discount on Bonds Payable
When bonds are issued for less than maturity value, a discount results.
The debit to interest expense reduces the amount of net income, but does not use cash.
The amount of amortization should be added back to net income.
**If bonds had been issued at a premium, the resulting amortization would have to be subtracted from net income.
25 - Operating Cash Flows: Indirect Method
Indirect Method - Increases and Decreases in Current Assets and Current Liabilities
Reflect the differences between the amount of revenue or expense recognized for net income and the amount of cash received or paid.
Asset increase, NI decrease
Asset decrease, NI increase
Liability increase, NI increase
Liability decrease, NI decrease
25 - Operating Cash Flows: Indirect Method
Indirect Method - Increase in Accounts Receivable
Unless an A/R is collected within the same period, there is no increase in cash.
Net income would have to be decreased by the amount of an uncollected account receivable.
The amount of the aggregate change in receivables (and other current assets) must be used to adjust net income to get the related cash flows. (EndBal - BegBal)
Increases and decreases in other current assets would be treated in the same manner.
25 - Operating Cash Flows: Indirect Method
Indirect Method - Increase in Accounts Payable
Unless A/P is paid within the same period, there is no decrease in cash.
Net income would have to be increased by the amount of the unpaid account payable.
The amount of the aggregate changes in payables (and other current liabilities) must be used to adjust net income to get the related cash flows. (EndBal - BegBal)
Increases and decreases in other current liabilities would be treated in the same manner.
25 - Operating Cash Flows: Indirect Method
Indirect Method - Increases and Decreases in Unearned Revenues
Differences between the amount of revenue recognized for net income and the amount of cash received.
The amount of these increases or decreases must be added back to or subtracted from net income to get the related cash flow.
Unearned Rev increase, NI increase
Unearned Rev decrease, NI decrease
25 - Operating Cash Flows: Indirect Method
Direct/Indirect Comparison
- Direct presents cash flows in terms of the specific sources from which cash was received/paid
- Indirect develops cash flows by adjusting net income and does not identify specific sources
- Either method will provide the same amount
- Either method will have the same format for the other major sections
- Direct is preferred by the FASB
- Both require disclosure of Noncash Investing and Financing activities
- Direct requires an additional schedule to reconcile net income
- Indirect requires an additional disclosure of the amount of cash paid for interest and dividends
26 - Notes to Financial Statements
Financial Report Disclosures- Summary of Significant Accounting Policies
A required footnote that discloses the principles and methods chosen by management where GAAP allows a choice.
Includes information about:
- Depreciation method
- Inventory valuation method
- Securities classified as cash and cash equivalents
- Basis for consolidation (amortization policies and revenue recognition policies)
No required in interim statements if the policies have not changed.
26 - Notes to Financial Statements
Financial Report Disclosures- Related Party Transactions
Disclose the following:
- Nature of the relationship between the related entities
- Description of all related party transactions for the years in which an income statement is presented
- Dollar amounts of the related party transactions for the years in which an income statement is presented
- Any receivables or payables from or to related parties as of the date of each balance sheet presented
26 - Notes to Financial Statements
Financial Report Disclosures- Development Stage Enterprises - Definition
An enterprise in which substantially all of its efforts are related to establishing a new business.
One of two criterion must be met to be classified as such:
- Principal operations have NOT begun
- If operations have begun, insignificant amounts of revenue have been generated by the company
26 - Notes to Financial Statements
Financial Report Disclosures- Development Stage Enterprises - GAAP and Required Statements
Required to apply GAAP. Normal operating costs during the development stage are expensed, not capitalized, in anticipation of future revenue.
Required Statements:
- Income Statement
- Balance Sheet
- Statement of Cash Flows
- Statement of Stockholders’ Equity
26 - Notes to Financial Statements
Financial Report Disclosures- Development Stage Enterprises - Required Disclosures
- Accumulated operating deficit from operating losses (in the OE section of the Balance Sheet
- Cumulative amounts in the Income Statement
- Disclosure that the firm is a development stage enterprise
- Disclosure that the firm was previously a development stage enterprise in the first year after the development stage is completed
26 - Notes to Financial Statements
Financial Report Disclosures- Noncurrent Liability Disclosures
- Combined aggregate amount of maturities on borrowings for each of the five years following the Balance Sheet
- Sinking fund requirements
- Aggregate amount of payments for unconditional obligations to purchase fixed or minimum amounts of goods/services
- Fair value of each financial debt instrument
- Nature of the firm’s liabilities, interest rates, maturity dates, conversion options, assets pledged as collateral, and restrictions
26 - Notes to Financial Statements
Financial Report Disclosures- Capital Structure Disclosures
- Rights and Privileges
- Number of shares issued during the fiscal period
- Liquidation preference of preferred stock (and if liquidation value is considerably in excess of par or stated value)
- Other Preferred Stock Disclosures (Aggregate or per-share amounts at which preferred stock can be called & Aggregate or per-share amounts of arrearages)
- Redeemable Preferred Stock (for each of the five years following the Balance Sheet and the amount of redemption requirements)
26 - Notes to Financial Statements
Financial Report Disclosures - Errors and Irregularities
Errors - unintentional
Irregularities - intentional
Require a footnote disclosure. If prior period income is reflected, an adjustment must be made to correct beginning RE and any other accounts affected.
26 - Notes to Financial Statements
Financial Report Disclosures- Illegal Acts
Disclose the nature and impact.
26 - Notes to Financial Statements
Management’s Discussion and Analysis (MD&A)
A narrative written by management.
- Management’s discussion about the operations of the firm, its liquidity, and capital resources
- Management’s view of the firm’s financial condition, changes in financial condition, and results of operations through analysis of the financial statements
- Forward-looking information is provided, including management’s general prognosis about future sales, effects of competition, and expected effects of general macroeconomic conditions.
26 - Notes to Financial Statements
Disclosures for the Effects of Changing Prices - Background
Both inflation (general price-levels) and specific price changes affect the interpretation of reported amounts.
26 - Notes to Financial Statements
General Price-Level Changes - Inflation
The increase in general prices for a period of time.
26 - Notes to Financial Statements
General Price-Level Changes - Deflation
The decrease in general prices for a period of time.
26 - Notes to Financial Statements
General Price-Level Changes - Consumer Price Index for All Urban Consumers (CPI-U)
An index reflecting the aggregate increase in the price of many goods and services used by individuals.
26 - Notes to Financial Statements
General Price-Level Changes - Nominal Dollars
Measurements in the price level in effect at a transaction date (not adjusted for inflation).
Financial statement amounts are measured in nominal dollars.
26 - Notes to Financial Statements
General Price-Level Changes - Constant Dollars
Measurements in the general price level as of a specific date.
Reflect an adjustment for inflation and allow comparisons using dollars with the same purchasing power.
Adjustments allow comparisons of dollar amounts for transactions occurring on different dates.
The effect of inflation is stripped away leaving “real” dollar measurements.
26 - Notes to Financial Statements
Specific Price Changes
The change in the price of a specific good or service over a period of time.
Restrictions: refer only to specific goods and services and are not necessarily correlated with inflation
26 - Notes to Financial Statements
Effects of General Changes - Purchasing Power
The purchasing power of an asset is the amount of goods and services that can be obtained by transferring the asset to another party.
During inflation, the purchasing power of an asset having a fixed unchangeable value decreases.
26 - Notes to Financial Statements
Monetary Items
The specific price of monetary items cannot change.
Examples:
- Cash
- Most receivables
- Accounts payable
- All liabilities payable in fixed dollar amounts
- Certain investments in debt securities
26 - Notes to Financial Statements
Nonmonetary Items
The specific price of nonmonetary items can change.
Examples:
- Inventory
- Plant assets
- Investments in equity securities
- Unearned rent
- Other liabilities payable in goods and services
26 - Notes to Financial Statements
Purchasing Power Gains and Losses
The change in purchasing power of an item due to a change in the general price level is measured only for monetary items because the specific price of nonmonetary items can change.
26 - Notes to Financial Statements
Purchasing Power Gains
Results from holding monetary assets during deflationary times or having monetary liabilities during inflationary times
26 - Notes to Financial Statements
Purchasing Power Losses
Results from holding monetary assets during inflationary times or having monetary liabilities during deflationary times
26 - Notes to Financial Statements
U.S. GAAP and IFRS Differences - Order of footnote presentation
- Statement of compliance with IFRS
- Summary of significant accounting policies
- Supporting information for FS items
26 - Notes to Financial Statements
U.S. GAAP and IFRS Differences - Summary of Significant Accounting Policies
Includes:
- Judgments and key assumptions made in applying those policies
- Measurement bases used for recognition
- Information enabling an assessment of the estimation uncertainty that could result in a material adjustment to the balances of assets and liabilities
26 - Notes to Financial Statements
U.S. GAAP and IFRS Differences - Footnotes
Should be disclosed in the order of those financial statement items
26 - Notes to Financial Statements
U.S. GAAP and IFRS Differences - Additional Items included in the Notes
- Amount of dividends proposed or declared before the statements were authorized for issue (US doesn’t require disclosure of proposed dividends)
- Additional information enabling an assessment of the firm’s objectives, policies, and processes for managing capital
26 - Notes to Financial Statements
U.S. GAAP and IFRS Differences - Hyperinflationary Economies
Firms operating in economies with very substantial inflation are required to provide disclosure of the impact of inflation.
Requires financial statements to be restated to reflect the current general price level.
Hyperinflation - 100% or more over three years
27 - Liquidity/Solvency and Operational
Financial Statement Ratio Analysis
The development of quantitative relationships between various elements of a firm’s FS.
Enables comparisons across firms, especially within the same industry, and facilitates identifying operating and financial strengths and weaknesses of a firm.
27 - Liquidity/Solvency and Operational
Liquidity/Solvency Ratios
Measure the ability of a firm to pay its obligations as they become due.
Working Capital Working Capital Ratio Acid-Test Ratio (Quick Ratio) Securities Defensive-Interval Ratios Times Interest Earned Times Preferred Dividend Earned Ratio
27 - Liquidity/Solvency and Operational
Working Capital
Measures the extent to which current assets exceed current liabilities.
CA - CL
27 - Liquidity/Solvency and Operational
Working Capital Ratio
Measures the quantitative relationship between current assets and current liabilities in terms of the “number of times” CA can cover CL.
CA / CL
27 - Liquidity/Solvency and Operational
Acid-Test Ratio (Quick Ratio)
Measures the quantitative relationship between highly liquid assets and CL in terms of the “number of times” that cash and assets that can be converted quickly to cash cover CL.
[Cash + (Net) Receivables + Marketable Securities] / CL
27 - Liquidity/Solvency and Operational
Securities Defensive-Interval Ratio
Measures the quantitative relationship between highly liquid assets and the average daily use of cash in terms of the number of days that cash and assets can be quickly converted to support operating costs.
[Cash + (Net) Receivables + Marketable Securities] / Average Daily Cash Expenditures
27 - Liquidity/Solvency and Operational
Times Interest Earned Ratio
Measures the ability of current earnings to cover interest payments for a period.
(Net Income + Interest Exp. + Income Tax) / Interest Exp.
27 - Liquidity/Solvency and Operational
Times Preferred Dividend Earned Ratio
Measures the ability of current earnings to cover preferred dividends for a period.
Net Income / Annual Preferred Dividend Obligation
27 - Liquidity/Solvency and Operational
Operational Activity Ratios
Measure the efficiency with which a firm carries out its operating activities.
Accounts Receivable Turnover Number of Days' Sales in Average Receivables Inventory Turnover Number of Days' Supply in Inventory Number of Days in Operating Cycle
27 - Liquidity/Solvency and Operational
Accounts Receivable Turnover
Measures the number of times that accounts receivables turnover in a period. Indicates the quality of credit policies and the efficiency of collection procedures.
(Net) Credit Sales / Average (Net) Accounts Receivable
Average A/R = (Beg. Bal + End. Bal) / 2
27 - Liquidity/Solvency and Operational
Number of Days’ Sales in Average Receivables
Measures the average number of days required to collect receivables. A measure of the average age of receivables.
365 / Accounts Receivable Turnover
27 - Liquidity/Solvency and Operational
Inventory Turnover
Measures the number of times that inventory items turnover during a period. Indicates over or under stocking of inventory or obsolete inventory.
Cost of Goods Sold / Average Inventory
Average Inventory = (Beg. Bal + End. Bal) / 2
27 - Liquidity/Solvency and Operational
Number of Days’ Supply in Inventory
Measures the number of days inventory is held before it is sold or used. Indicates the efficiency of general inventory management.
365 / Inventory Turnover
27 - Liquidity/Solvency and Operational
Number of Days in Operating Cycle
Measures the average length of time to invest cash in inventory, convert the inventory to receivables, and collect the receivables. It measures the time to go from cash back to cash.
28 - Profitability and Equity
Profitability Ratios
Measure aspects of a firm’s operating results on a relative basis.
Profit Margin (on Sales) Return on Total Assets Return on Common Stockholders' Equity Return on Owners' (all Stockholders') Equity Earnings Per Share (EPS - Basic Formula) Price-Earnings Ratio (P/E Ratio) Common Stock Dividends Pay Out Ratio (Total/Per Share Bases) Common Stock Yield
28 - Profitability and Equity
Profit Margin (on Sales)
Measures the net profitability on sales.
Net Income / (Net) Sales
28 - Profitability and Equity
Return on Total Assets
Measures the rate of return on total assets and indicates the efficiency with which invested resources are used.
(Net Income + Interest Expense) / Average Total Assets
Average Total Assets = (Beg. Bal + End. Bal) / 2
28 - Profitability and Equity
Return on Common Stockholders’ Equity
Measures the rate of return on common stockholders’ investment.
(Net Income - Preferred Dividend) / Average Common Stockholders’ Equity
Average Common Stockholders’ Equity = (Beg. Bal + End. Bal) / 2
28 - Profitability and Equity
Return on Owners’ (all Stockholders’) Equity
Measures the rate of return on all stockholders’ investment.
Net Income / Average Stockholders’ Equity
Average Stockholders’ Equity = (Beg. Bal + End. Bal) / 2
28 - Profitability and Equity
Earnings Per Share (EPS - Basic Formula)
Measures the income earned per share of common stock. Indicates ability to pay dividends to common shareholders.
(Net Income - Preferred Dividends) / Weighted Average Number of Shares Outstanding
28 - Profitability and Equity
Price-Earnings Ratio (P/E Ratio)
Measures the price of a share of common stock relative to its latest earnings per share. Indicates a measure of how the market values the stock, especially when compared with other stocks.
Market Price for a Common Share / EPS
28 - Profitability and Equity
Common Stock Dividends Pay Out Ratio (Total Basis and Per Share Basis)
Measures the extent (percent) of earnings distributed to common shareholders.
Total Basis = Cash Dividends to Common Shareholders / Net Income to Common Shareholder
Per Share Basis = Cash Dividends per Common Share / Earnings per Common Share
28 - Profitability and Equity
Common Stock Yield
Measures the rate of return per share of common stock.
Dividend per Common Share / Market Price per Common Share
28 - Profitability and Equity
Equity/Investment Leverage Ratios
Provide measures of relative sources of equity and equity value.
Debt to Equity Ratio Owners' Equity Ratio Debt Ratio Book Value per Common Stock Book Value per Preferred Share
28 - Profitability and Equity
Debt to Equity Ratio
Measures relative amounts of assets provided by creditors and shareholders.
Total Liab. / Total Shareholders’ Equity
28 - Profitability and Equity
Owners’ Equity Ratio
Measures the proportion of assets provided by shareholders.
Shareholders’ Equity / Total Assets
28 - Profitability and Equity
Debt Ratio
Measures the proportion of assets provided by creditors. Indicates the extent of leverage in funding the equity.
Total Liab. / Total Assets
28 - Profitability and Equity
Book Value per Common Stock
Measures the per share amount of common shareholders’ claim to assets.
Common Shareholders’ Equity / Number of Outstanding Common Shares
28 - Profitability and Equity
Book Value per Preferred Share
Measures the per share amount of preferred shareholders’ claim to assets.
Preferred Shareholders’ Equity (including dividends in arrears) / Number of Outstanding Preferred Stocks
29 - First-Time Adoption of IFRS
IFRS 1
The first time adopter must apply all standards effective at the reporting date of the entity’s first IFRS compliant financial statements and this application is retrospective.
29 - First-Time Adoption of IFRS
When does IFRS 1 apply?
When the most recent FS were prepared:
- In compliance with US GAAP
- In conformity with IFRS, except that an explicit and unreserved statement of compliance was not presented
- In compliance with US GAAP with reconciliation to IFRS
- In conformity with IFRS, but for internal use only
- In conformity with IFRS for consolidation purposes, but without a complete set of FS or without presenting FS of previous periods.
29 - First-Time Adoption of IFRS
Key Dates
First Reporting Date = the year end date for the period for which IFRS is first applied.
Transition Date = the opening date of the earliest period for which full comparative financial statements under IFRS are presented.
29 - First-Time Adoption of IFRS
Required Financial Statements
- 3 statements of financial position
- 2 statements of comprehensive income
- 2 separate income statements (if presented)
- 2 statements of cash flows
- 2 statements of changes in equity
29 - First-Time Adoption of IFRS
Required Reconciliations
Must present reconciliations of US GAAP to IFRS to explain the impact of the adoption on equity and comprehensive income.
- Reconciliation of equity as of the transition date
- Reconciliation of equity as of the most recent US GAAP statement date
- Reconciliation of US GAAP total comprehensive income
29 - First-Time Adoption of IFRS
Mandatory Exceptions
IFRS 1 prohibits the retrospective application of IFRS to these transactions.
- Derecognition of financial assets and liabilities
- Hedge accounting
- Assets held for sale and discontinued operations
- Certain aspects of accounting for non-controlling interest
- Use of certain estimates
29 - First-Time Adoption of IFRS
Voluntary Exceptions
IFRS 1 permits exclusion for retrospective application of IFRS for these transactions.
- Business combinations
- Share-based payments
- Insurance contracts
- PPE
- Leases
- Employee benefits
- Effects of foreign exchange rates
- Compound financial instruments
- Assets and liabilities of subsidiaries and joint ventures
30 - Cash, Modified Cash, Income Tax
Cash Basis Financial Statements
Based only on cash receipts and disbursements.
Revenues are recognized when cash is received and expenses are recognized when cash is disbursed (no matching).
A Balance Sheet will only show Cash and Equity; no liabilities or other assets.
Appropriate for small, very closely held businesses where the owners whose primary interest and survival depends on cash flows.
30 - Cash, Modified Cash, Income Tax
Modified Cash Basis Financial Statements
Combination of cash basis and accrual basis.
Acceptable if the modification(s) have substantial support in practice:
- Modification is equivalent to an element of accrual basis accounting
- Modification is logical and consistent with GAAP
30 - Cash, Modified Cash, Income Tax
Income Tax Basis Financial Statements
Using federal income tax rules and regs that a firm uses, or expects to use, in filing an income tax return.
Income is recognized in the period taxable and expenses are recognized in the period deductible.
Some items are never recognized for tax purposes, called permanent differences.
30 - Cash, Modified Cash, Income Tax
Income Tax Basis Financial Statements - Adjustments
- If an adjustment relates to an error in the tax return of a prior year, then a prior period adjustment is appropriate.
- If the adjustment relates to an item that is not an error and IS NOT BS related, the adjustment would be treated as a current period expense or income.
- If the adjustment relates to an item that is not an error and IS BS related, the adjustment would be treated as a prior period adjustment.
30 - Cash, Modified Cash, Income Tax
OCBOA
Other Comprehensive Basis of Accounting
Major non-GAAP comprehensive bases of accounting used by non-public business entities.
30A - Auditing OCBOA
Auditor’s Objective
Appropriately address the special considerations that are relevant to:
- The acceptance of an engagement
- The planning and performance of an engagement
- Forming an opinion and reporting on the financial statements
31 - Personal Financial Statements
Purpose
Prepared for an individual or group of related individuals; not a business enterprise.
Prepared in conjunction with personal borrowing, personal financial planning, contract requirements, or legal requirements.
31 - Personal Financial Statements
Types of Personal Financial Statements
Statement of Financial Condition (Balance Sheet)
Statement of Changes in Net Worth (optional)
31 - Personal Financial Statements
Inappropriate Statements
Income Statement
Statement of Cash Flows
31 - Personal Financial Statements
Statement of Financial Condition
Based on accrual accounting using fair value.
Should report:
- Assets at estimated current values
- Liabilities at estimated current amounts
- Personal Net Worth (Assets - Liabilities)
- Estimated income taxes (as if assets were realized and liabilities were liquidated)
31 - Personal Financial Statements
Statement of Changes in Net Worth
Shows the amounts and causes of the changes in net worth for an individual.
Assets and liabilities are recognized on an accrual basis.
Increases in Estimated Values of Assets - Decreases in EV of Assets - Increases in Estimated Amounts of Liabilities + Decreases in EA of Liabilities
31 - Personal Financial Statements
Asset Valuation
Assets should be reported at estimated current values based on an assumed arms-length transaction, net of disposal costs.
Set Asset Value Guidelines table on page 168.
31 - Personal Financial Statements
Asset Disclosure
Disclose the face value of life insurance policies.
Disclose significant interest in separate businesses as a single line item and amount for each business interest, measured at the estimated CV of the net assets.
Disclose interest in a business activity that does not function as a separate business as separate assets and liabilities that comprise the business activity.
Disclose future interests and rights if they are:
- Fixed or determinable in amount
- Not contingent on the holder’s life expectancy or the occurrence of a specific event
- Do not require future performances by the holder
31 - Personal Financial Statements
Asset Presentation
Listed in the Statement of Financial Condition in the order of liquidity, not separated into current/non-current categories.
31 - Personal Financial Statements
Liability Valuation
Reported at estimated current amounts based on the lower of:
- The amount at which the liability could be settled currently (liquidation value)
- The present value of cash to be paid in future settlement
See Liability Valuation Guidelines table on page 169.
31 - Personal Financial Statements
Liability Disclosure
Commitments or other liabilities should be recognized as a personal liability only if the obligations:
- Are to pay a fixed or determinable amount
- Are not contingent on others life expectancy or the occurrence of a specific event
- Do not require future performances by others
31 - Personal Financial Statements
Liabilities - Income Tax Provision
Computed as if the assets and liabilities were disposed/settled at fair value and the resulting excess over their tax basis were taxed under the currently applicable laws and rates.
For Assets, this amount is reported as a separate line item between Liabilities and Net Worth.
31 - Personal Financial Statements
Liability Presentation
Listed in the Statement of Financial Condition in the order of maturity, not separated into current/non-current categories.
31 - Personal Financial Statements
Net Worth Valuation and Presentation
Net Worth = Assets (at current estimated value) - Liabilities (at current estimated amount, including a provision for income tax on the estimated taxable gain.
Shown in the Statement of Financial Condition after liabilities in a manner similar to Capital.
