FAR - Conceptual Framework and Financial Reporting Flashcards
Financial accounting and reporting is concerned w/providing…
relevant information to external users (e.g. investors, creditors etc)
3 aspects of financial reporting that GAAP addresses
- Recognition: A recognized item is recorded in an account, which ultimately affects the financial statements
- Measurement: Concerns the dollar amount assigned to an item
- Disclosure: Many unrecognized amounts are reported in the footnotes to complete the portrayal of the firm’s financial position and performance
3 accounting standard-setting mechanism in the US
- Financial Accounting Foundation (FAF)
- Financial Accounting Standard Board (FASB)
- Financial Accounting Standards Advisory Council (FASAC)
Financial Accounting Foundation (FAF)
The FAF:
- Appoints members of the FASB
- Ensures adequate funding for the FASB
- Exercises oversight over the FASB
Financial Accounting Standards Board (FASB)
The FASB is 1 of the 3 parts of the current accounting standard-setting body in the US.
The FASB is an independent body, subject only to FAF
Financial Accounting Standards Advisory Council (FASAC)
FASAC provides guidance on major policy issues, project priorities, and the formation of task forces
The mission of the FASB
- Improve the usefulness of financial reporting
- Maintain current accounting standards
- Promptly address deficiencies in accounting standards
- Promote international convergence of accounting standards
- Improve the common understanding of the nature and purposes of info in the financial reports
Primary Qualitative Characteristics for information to be useful
- Relevance
- Faithful representation
For information to be useful for decision-making, it must be both relevant and a faithful representation of the economic phenomena that it represents
Relevance
Information is relevant if it makes a difference to decision-makers in their role as capital providers
- Predictive value
- Confirmatory value
- Materiality
Relevance - predictive value
Information has predictive value if it helps you form expectations about future events
Relevance - confirmatory value
Confirmatory value enables users to check and confirm earlier predictions or evaluations
Relevance - materiality
Information that’s material will impact a user’s decision
Faithful representation
Information is representationally faithful when it is:
- Complete
- Neutral
- Free from error
Faithful representation - completeness
Info is complete if it includes all data necessary to be faithfully representative
All of the information that a user needs in order to form a clear picture of the results, financial position, and cash flows of a business are included in the financial statements. This also means that no information is omitted that might have led a user to have a different opinion of the business.
Faithful representation - neutral
Info is neutral when it’s free from any bias intended to attain a prespecificed result or to encourage/discourage certain behavior
Faithful representation - free from error
Info is free from error if there are no omissions or errors
Enhancing Qualitative Characteristics
- Comparability
- Verifiability
- Timeliness
- Understandability
Enhancing characteristics - comparability
Comparability is the degree to which accounting standards and policies are consistently applied from one period to another.
Enhancing characteristics - verifiability
Information is verifiable if different knowledgeable and independent observers could reach similar conclusions based on the information
Enhancing characteristics - timeliness
Timeliness is how quickly information is available to external users. The less timely (thus resulting in older information), the less useful information is for decision-making.
Enhancing characteristics - understandability
Information is understandable if the user comprehends it w/in the decision context at hand.
Note, users are assumed to have basic understanding of business and accounting
Accounting Assumptions
- Entity
- Going-Concern
- Unit-of-Measure
- Time Period
Entity Assumption
We assume that there is a separate accounting entity for each business organization
More practical: business owner’s transactions and company’s transactions are kept separate
Going Concern Assumption
Organization is assumed to remain in business for the foreseeable future
Unit-of-Measure Assumption
All transactions must be consistently recorded using the same currency of the country in which the business operates.
Time Period Assumption
The accounting guideline that allows the accountant to divide up the complex, ongoing activities of a business into periods of a year, quarter, month, week, etc
Accounting Principles
- Measurement (typically historical cost)
- Revenue Recognition - Revenues are recognized when performance obligation to customer has been met and the revenue is earned or realized; the related expenses are recognized (matching principle)
- Expense Recognition
- Full Disclosure Principle - financial statements should present all information needed by an informed reader to make an economic decision
Cost of Goods Manufactured
Direct computation:
Direct materials + Direct labor + manufacturing overhead - ending work in process = cost of goods manufactured
Indirect computation:
Beg finished goods + cost of goods manufactured - ending finished goods = cost of sales
Billings in excess of costs of long-term contracts is similar to unearned revenue and is always reported as…
Current liabilities
Costs in excess of billings on long-term contracts should be reported on the balance sheet as
current assets
Consignment goods should be included in
inventory at their cost
Comprehensive income is defined as the change in
equity of a business during a period from transactions of nonowner sources
Comprehensive income is net income +/- unrealized gains and losses on debt securities classified as available-for-sale are recognized in comprehensive income for the period.
Comprehensive income includes all changes in equity during a period except those resulting from investments by owners and distributions to owners
Accumulated other comprehensive income should be reported as a component of
Equity and separate from retained earnings or additional paid-in capital
If debt security is available-for-sale, unrealized gains/losses prior to their sale are
not reported in net income
Debt securities that are held-to-maturity are reported at amortized cost, which means
there are no holding gains. Any decreases or increases in fair value are reported neither in net income nor as part of other comprehensive income.
Items typically included in other comprehensive income
- Unrealized gains/losses on debt securities classified as available-for-sale
- Unrecognized pension and postretirement benefit cost/gains
- Foreign currency translation adjustments
- Certain deferred gains/losses from derivatives
Components of other comprehensive income can be shown either…
- net of tax-related effects
- before tax-related effects with the aggregate income tax effects shown as one amount.
Comprehensive income can be displayed in the financial statements either…
- as a separate statement that begins with net income
- continuation of net income presented at the bottom of the income statement
The correction of an error in the financial statements of a prior period is a prior period adjustment which is to be shown
net of tax as an adjustment to the beginning balance of retained earnings
Beg. prepaid insurance + insurance payments − insurance expense = end. prepaid insurance
Cash paid to suppliers
Cash paid to suppliers = COGS + (End. inv. − Beg. inv.) + (Beg A/P − End A/P)
Per ASC Topic 230, investing and financing activities that do not affect cash but do affect recognized assets and liabilities should be presented in
a separate schedule to accompany the statement of cash flows.
Examples of such items include:
- 1.Conversion of debt to equity
- 2.Acquisition of assets by:
- Incurring a mortgage
- Entering into a capital lease
- Issuing stock
- Exchange of noncash assets or liabilities for other noncash assets or liabilities.
Cash Received from Customers
Cash Receipts from Customers = Net Sales + (Beginning Accounts Receivable − Ending Accounts Receivable)
Cash payment to employees
Cash Payments to Employees = Salaries Expense + (Beginning Salaries Payable − Ending Salaries Payable
Cash interest payments
Cash interest payments = Interest Expense + (Beg. interest payable - Ending interest payable)
Income Tax Payments (Direct Method)
Income Tax payments = Income Tax Expense + (Beg. Income Tax payable - End Income Tax payable)
Financing activities include the repayment of
debt principal
Therefore, payment of financial lease (principal) applies
Dividends/interest revenue received is an… (for cash flow statement)
operating cash flow
Cash flow from financing activities include all cash flows involving
liabilities and owner’s equity
Cash paid for prepaid insurance (or any prepaid assets)
Cash paid for prepaid insurance (or any prepaid assets) = Insurance expense + (end prepaid insurance - beg prepaid insurance)
Cash flows from available-for-sale and held-to-maturity investments are both included in
cash flow for investing activities
Monetary asset
An asset, such as cash, A/R or a note receivable in which the amount is a fixed, stated amount.
Holding these assets during periods of inflation will result in a loss of purchasing power
non-monetary items
non-monetary items = assets/liabilities whose amounts may change over time in a monetary unit (e.g. USD)
Examples: inventory, PP&E, obligations under warranties, accumulated deprecation etc.
Required disclosures regarding risks and uncertainties include
- Nature of operations
- Use of estimates in the preparation of financial statements.
- Current vulnerabilities due to concentrations
Note: current vulnerability due to a possible recession is not a required disclosure
current cost income from continuing operations
current cost income from continuing operations = revenue - COGS
A company that wishes to disclose information about the effect of changing prices should report this information in
supplementary information to the financial statements
The Consumer Price Index is used to compute information on a
constant dollar basis.
When a component of a business has been discontinued during the year, this component’s operating losses of the current period should be included in the
Income Statement as part of the loss on disposal of the discontinued component
to qualify as a cash equivalent, ASC Topic 305 requires the
original maturity date to be three months or less from the date of purchase
Therefore, certificates of deposit or any other instruments having an original maturity date greater than three months from the date of purchase are not considered cash equivalents
Before recording an exit or disposal acitivity, you must record depreciation
When the cash received from the sale > asset’s net book value (asset cost - accumulated depreciation), then
gain is recognized
Gain on disposal
Actual gains on disposal (when the decision to discontinue the operation and the disposal occur in the same period) are recognized but estimated gains are not
A gain occurs when the net proceeds from the sale of the component > book value of the net assets of the component
Loss on disposal
When the book value of the net assets of the component > (fair value - cost of disposal) -> loss is recognized
If the actual disposal loss is different from the estimated loss recognized previously, then in the period of disposal, the difference is recognized as a gain or loss
A discontinued operation is when a component or group of components of an entity are
- Disposed for by sale or other than sale, or classified as held-for-sale and
- The disposal represents a “strategic shift that has (or will have) a major effect on an entity’s operation and financial results”
A strategic shift includes the disposal of a major geographical area, a major line of business, a major equity method investment, or other major parts of the entity
Impairment loss
Impairment loss = fair value - carrying value
First, you must apply the impairment test, which entails comparing the carrying value to the asset’s undiscounted expected net future cash flows.
If the undiscounted expected net future cash flows > asset’s carrying value -> asset is impaired
Operating cycle
Operating cycle refers to the days required for a business to receive inventory, sell the inventory, and collect cash from the sale of the inventory. This cycle plays a major role in determining the efficiency of a business.
Operating cycle = inventory period + A/R period
Combined financial statements are financial statements prepared for companies that are owned by the same parent company or other owner.
Combined financial statements are prepared by simply combining the subsidiaries’ financial statement classifications, with appropriate elimination of intercompany transactions, balances, and profit (loss).
The excess of the equipment’s market value over its carrying amount is allocated to the equipment and amortized over the equipment’s useful life. The unamortized portion of the excess of the market value over the carrying amount of the equipment is then reported as part of plant and equipment. Only the excess of the acquisition cost over the market value of the net identifiable assets acquired is reported as goodwill. The excess of the market value over the carrying amount of the equipment is capitalized and subsequently amortized over the equipment’s useful life, not expensed on the date of the acquisition.
When the fair value of a subsidiary’s assets is greater than book value, it is as though the parent paid more for the assets than the subsidiary paid for those assets. Using the equity method of accounting for the investment, the parent must depreciate the excess of fair value over book value. That equity entry would be: DR: Equity Revenue - to reduce it by the amount of depreciation on the excess of fair value over book value, and CR: Investment in Subsidiary - to offset a portion of the net income (or increase the amount of net loss) recognized from the subsidiary. Thus, both accounts would be decreased.
On January 1, 20x6 Ritt Corp. purchased 80% of Shaw Corp.’s $10 par common stock for $975,000. On this date, the carrying amount of Shaw’s net assets was $1,000,000. The fair values of Shaw’s identifiable assets and liabilities were the same as their carrying amounts except for plant assets (net) which were $100,000 in excess of the carrying amount. Those plant assets had a 10-year remaining life, depreciated on a straight-line basis. The fair value of the 20% noncontrolling interest in Shaw was properly determined to be $200,000 at that time. For the year ended December 31, 20x6, Shaw had net income of $190,000 and paid cash dividends totaling $125,000. Which one of the following is the amount of goodwill that should be recognized as a result of the business combination?
Answer: 75k
Goodwill is determined as the excess of investment value over the fair value of the subsidiary’s net assets. Investment value is the sum of the parent’s investment (which is the fair value of consideration paid) + the fair value of any noncontrolling interest, which in this question is $975,000 + $200,000 = $1,175,000. The fair value of Shaw’s identifiable net assets is book value $1,000,000 + write up in plant assets $100,000 = $1,100,000. Therefore, goodwill is investment value $1,175,000 - fair value of identifiable assets $1,100,000 = $75,000, the correct answer.
The amount of an investment eliminating entry is the balance in the investment account as of the beginning of the period being consolidated.
Intercompany Items
The primary types of intercompany transactions and related intercompany balances are:
- Receivables/payables
- Revenue/expenses
- Inventory
- Fixed assets
- Bonds
Intercompany transactions
Include buying, selling, and transfers. They also include the profit/losses and the outstanding balances that result from these transactions
Downstream transaction
A downstream transaction is when the parent sells to the subsidiary. Any intercompany profit that results from the sale will be on the books to the parent
Upstream transaction
An upstream transaction is when the subsidiary sells to the parent. Any intercompany profit that results from the sale will be on the books of the subsidiary
From the point of view of the consolidated entity, any intercompany receivables or payables from parent to subsidiary or vice versa are not payable to or receivable from any outside company.
In other words, the consolidated entity does not have a receivable or payable.
When computing consolidated income, the objective is to restate the accounts as if the intercompany transactions had not occurred.
When a subsidiary prepares separate financial statements, intercompany receivables (and payables) should be reported in the balance sheet as a separate line item.
When consolidated financial statements are prepared by the parent company, all intercompany receivables (and payables) should be eliminated to avoid overstating assets and liabilities.
Par Corp. owns 60% of Sub Corp.’s outstanding capital stock. On May 1, year 2, Par advanced Sub $70,000 in cash, which was still outstanding at December 31, year 2. What portion of this advance should be eliminated in the preparation of the December 31, year 2, consolidated balance sheet?
Answer: 70k
Consolidated statements are prepared as if the acquirer and acquiree were one economic entity. From the point of view of the consolidated entity, the $70,000 is not payable to or receivable from any outside company. In other words, the consolidated entity does not have a receivable or payable. Therefore, the entire $70,000 payable on Sub’s books and the entire $70,000 receivable on Par’s books must be eliminated against each other. The level of ownership (60%) does not affect this elimination.
Sun, Inc. is a wholly owned subsidiary of Patton, Inc. On June 1, year 1, Patton declared and paid a $1 per share cash dividend to stockholders of record on May 15, year 1. On May 1, year 1, Sun bought 10,000 shares of Patton’s common stock for $700,000 on the open market, when the book value per share was $30. What amount of gain should Patton report from this transaction in its consolidated income statement for the year ended December 31, year 1?
Answer: $0
The requirement is to determine the amount of gain to be reported on the consolidated income statement when a wholly owned subsidiary purchases parent company stock. A parent company reports no gain or loss when a wholly owned subsidiary purchases its common stock.
In effect, the consolidated entity is purchasing treasury stock when the purchase is made, and gains are not recognized on treasury stock transactions. The dividends paid by the parent to the subsidiary also do not affect income because such intercompany transactions are eliminated when consolidated financial statements are prepared. Therefore, $0 gain should be reported by the consolidated entity.
Basic EPS
Basic EPS = (NI - preferred dividend)/weighted avg common shares outstanding
Operating segments
Operating or business segments are identified in the same manner that mangement segments the company for purposes of making operating decisions
Operating segments must have 3 characteristics
- The segment is involved in revenue producing and expense incurring activities
- The operating results of the segment are reviewed by the company’s chief operating decision maker on a regular basis
- There is discrete financial info available for segment
An operating segment becomes a reportable segment if it meets 1 or more of the following 3 quant tests
- The operating segment’s revenue from all sources (internal and external) is 10% or more of the combined revenues of all of the company’s reported operating segments
- The operating segment’s operating profit/loss is 10% or more of the greater of the following 2 amounts:
- The combined operating profit of all operaitng segments that didnt’ report an operating loss
2.
- The combined operating profit of all operaitng segments that didnt’ report an operating loss
Earnings per share amounts must be presented for
(1) income from continuing operations, and
(2) net income.
2 or more operating segments may be aggregated into a single operating segment if all of the aggregation criteria are met, or if after performing the 10% test a majority of the aggregation criteria are met.
NFP: Contribution recognition
All unconditional contributions are recognized as contribution revenue in the period in which the contribution is made, regardless of whether it’s received in cash. Donations other than cash are recorded at fair value as of the date of the gift
Conditional contributions revenue recognition
Conidition contributions depend on the occurrence of some future, uncertain events.
Thus, revenue recognition occurs when the condition is met or the chance of not meeting the conditions becomes remote
The NFP should account conditional contributions received (e.g. cash is deposited) as a refundable advance (liability) until the condition is met
2 categories for revenue
-
Contributions with donor restrictions (4 categories)
- program or purpose restriction - resources restricted for specified operaitng purposes
- time restrictions - resources available after a specified time has elapsed
- capital restrictions - resources restricted for acquisition/construction of capital assets
- resources not available for expenditure at any time, although earnings on the resources may be expended -> “endowments”
- Contributions w/out donor restrictions - these provide resources that are available for expenditure in the current period for any purpose
Net patient service revenue is the amount charged to patients less the contractual adjustments and discounts.
