FAR CPA Lessons 1-18 Flashcards
Define - GAAP
The rules of financial reporting for business enterprises. GAAP are also called accounting standards.
What are the 3 aspects of financial reporting?
- Recognition
- Measurement
- Disclosure
Explain Recognition
A recognized item is recorded in an accout and ultimately affects the financial statements
Explain Measurement
Concerns the dollar amount assigned to an item
Explain Disclosure
Many unrecognized amounts are reported in the footnotes to complete the portrayal of the firm’s financial position and performance
Identify the major organizations in the U.S. accounting standards
- Financial Accounting Standards Board (FASB)
- Securities and Exchange Commission (SEC)
- American Institute of Certified Public Accountants (AICPA)
- Financial Accounting Foundation (FAF)
- Financial Accounting Standards Advisory Council (FASAC)
- FASB’s Emerging Issues Task Force (EITF)
What is the Financial Accounting Standards Board (FASB)
The private sector standard setting board in the United States - Establishes financial accounting standards for business entities. The FASB is an independent body, subject only to the FAF.
What is the Securities and Exchange Commission (SEC)
The federal government agency that administers the securities laws of the United States. Has the authority to penalize firms when financial statements do not comply with GAAP.
What are registrants
Firms that register with the SEC
What is the American Institute of Certified Public Accountants (AICPA)
The national professional organization for practicing CPAs which provides members with resources, information and leadership
What are the 3 parts of the current accounting standard-setting mechanisms?
- FASB
- FAF (Financial Accounting Foundation)
- FASAC (Financial Accounting Standards Advisory Council
What is the Financial Accounting Foundation (FAF)
They appoint members of the FASB and it’s advisory councils, ensure FASB’s funding and oversee FASB
What is the Financial Accounting Stanadard Advisory Council (FASAC)?
Provides guidance on major policy issues, project priorities and the formation fo task forces
Mission of 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 information in financial reports.
What is FASB’s Emerging Issues Task Force (EITF)
Formed to consider emerging reporting issue and to accelerate the process of establishing rulings on such issues - if a consensus of 15 members is reached the issue does not go to FASB
How does FASB issue an amendment?
By releasing an accounting standards update
Which group writes GAAP
FASB
Components of external financial reports
- Income Statement
- Statement of Comprehensive Income
- Balance Sheet
- Statement of Changes in Owner’s Equity
- Statement of Cash Flows
- Footnote disclosures and supplementary schedules
- Auditor’s Opinions
Define The Accounting Standards Codification (ASC)
The compilation and organization of all GAAP sources
Is GAAP accrual based or cash based?
Accrual Based
Define accrual based accounting
Recognizes and reports the economic activities of the firm in the period the activity was incurred, regardless of when the cash activity takes place
a debit _____ an asset account
increases
Prepaid expenses is a(n) _______ account
asset account
cash out is a ______ and cash in is a _____
credit; debit
a credit _____ a liability account
increases
a debit ______ an expense account
increases
a debit ______ a revenue account
decreases
What is the Accounting Standard Codification
The compilation of authoritative U.S. GAAP principles for nongovernmental entities
**The Codification is the sole source of U.S. GAAP, for nongovernmental entities.
FASB codification does not include?
- Cash Basis
- Other comprehensive basis of account
- Income tax basis
- Regulatory account principles
Define Replacement cost
The amount of cash or its equivalent that would have to be paid if the same or equivalent assets were acquired currently
Describe the goals and purpose of the Codification.
The online, real-time database by which users access the Codification.
- Simplify the structure and accessibility of authoritative GAAP.
- Provide all authoritative literature in a single location.
- Reduce the time and effort required to research an accounting issue.
- Reduce the risk of noncompliance with GAAP.
- Facilitate updating of accounting standards.
- Assist the FASB with research and convergence (IFRS) efforts.
Illustrate how you would research using the Codification.
- Browse the structure (illustrated above) in the menu provided.
- Search by key word(s); this mode allows narrowing of a search both by related term and by major area within the Codification structure.
- Enter the specific Codification location (using the numerical system within the Codification); this is designed for users who know their topic and section of interest.
- Search by previous GAAP standard number (e.g., by FAS 13).
List the 9 areas of the codification
- General principles (100)
- Presentation (200)
- Assets (300)
- Liabilities (400)
- Equity (500)
- Revenue (600)
- Expenses (700)
- Broad transactions (800) (
- Industry (900)
List the 9 areas of the codification
- General principles (100)
- Presentation (200)
- Assets (300)
- Liabilities (400)
- Equity (500)
- Revenue (600)
- Expenses (700)
- Broad transactions (800)
- Industry (900)
Describe the objective of financial reporting.
To provide information about the entity useful to current and future investors and creditors in making decisions as capital providers.
Describe the qualitative characteristics of accounting information.
Relevance and 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.
Define Conceptual Framework
Guides the standard setting process so that GAAP is cohesive and internally consistent
Is based on the overriding objective of financial reporting, which is decision useful
What is included in relevance?
- Predictive Value
- Confirmatory Value
- Materiality
What is included in faithful representation?
- Completeness
- Neutrality
- Understand-ability
Define Relevance
Information is relevant if it makes a difference to decision makers in their role as capital providers.
Define Predictive Value
Information has predictive value if it assists capital providers in forming expectations about future events.
Define Confirmatory value
Information has confirmatory value if it confirms or changes past (or present) expectations based on previous evaluations.
Define Materiality
Information that is material will impact a user’s decision.
Define Faithful representation
Information faithfully represents an economic condition or situation when the reported measure and the condition or situation are in agreement.
Define Completeness
Information is complete if it includes all data necessary to be faithfully representative.
Define Neutral
Information is neutral when it is free from any bias intended to attain a prespecified result, or to encourage or discourage certain behavior.
Define Free from Error
Information is free from error if there are no omissions or errors.
Define Enhancing Characteristics
These are complementary to the primary characteristics and enhance the decision usefulness of financial reporting information that is relevant and faithfully represented.
Define Comparability
The quality of information that enables users to identify similarities and differences between sets of information.
Define Verifiability
Information is verifiable if different knowledgeable and independent observers could reach similar conclusions based on the information.
Define Timeliness
Information is timely if it is received in time to make a difference to the decision maker. T
Define Understandability
Information is understandable if the user comprehends it within the decision context at hand.
List and describe the assumptions in the conceptual framework.
- Entity - The entity is separate and distinct from its owners
- Going Concern - A business has an indefinite life that extends beyond the life of its owners
- Unit of Measure - Everything is measured in terms of a stable monetary unit of measure, not adjusted for inflation
- Time Period - The indefinite life is broken into timeframes, such as a year, a quarter, a month etc.
List and describe the principles in the conceptual framework.
- Revenue Recognition - When an entity satisfies a performance obligation
- Expense Recognition - Expenses are matched with the revenue generated by those expenses
- Measurement
- Full Disclosure
Explain historical cost
Cost of the asset at the date it was purchased - no adjustments
example - Land
Explain net book value
Historical cost less accumulated depreciation
example - Plant and Equipment
Explain Realizable Value
The initial value less a contra account
example - Accounts receivable less allowance for doubtful accounts
Explain Replacement Cost
Lower cost or market or lower cost of net realizable value
Example - Inventory
Explain Net Present Value
The present value of future cash flows - we discount those values back to today
example - bonds
Explain Fair Value
Items that have been impaired on our financial statements
example - Investments
Define Financial capital maintenance
As long as dividends do not exceed earnings, and earnings is not negative, financial capital has been maintained.
**GAAP is based on financial capital maintenance
Define Physical capital maintenance
This concept holds that earnings cannot be recognized until the firm has provided for the physical capital used up during the period. To measure the capital used up, changes in price level must be considered.
Define Immediate Recognition
Requires that items carried as assets in prior periods that are discovered to be impaired in value be charged to expense (e.g., a patent that is determined to be worthless).
Explain systematic and rational allocation
should be based on a formula that is logical and acceptable to other unbiased accountants
List and describe the constraints in the conceptual framework.
Cost-Benefit - The cost of providing the information should not outweigh the benefit -however you cannot use constraint to ignore information that is material
Discount cash flows
Single cash flow value is discounted using the risk-adjusted rate
Expected cash flows
Probability-weighted cash flows are discounted using the risk-free rate (Assigned a percentage to make weighted)
Explain Conservatism
Reporting the less optimistic amounts - used to avoid misleading internal and external users of the financial statements. Unless it is unlikely for the conservative amount to be accurate - overly conservative estimates can be misleading.
Explain Recognition and Measurement Criteria
Definition—The definition of a financial statement element is met.
Measurability—There is an attribute to be measured
Relevance—The information to be presented in the financial report is capable of influencing decisions. The information is timely, has predictive ability, provides feedback value, and is material.
Faithful Representation—The information is complete, neutral and free from material error.
Define Assets
Resources that have probable future benefits to the firm, controlled by management, resulting from past transactions. Note the three aspects of this definition.
Define Liabilities
Probable 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.
Define Comprehensive Income
Accounting income (transaction based) plus certain holding gains and losses and other items. It includes all changes in equity other than investments by owners and distributions to owners.
The most relevant measurement of an entity’s liabilities at initial recognition and fresh-start measurements should always reflect
the credit standing of the entity.
Define Principal Market
The market available to the entity with the greatest volume and level of activity for item
Define the Most advantageous market
The market available to the entity that maximizes selling price or minimizes transfer price
How do you decide which market to use to determine fair value?
Use transaction costs to determine which market to use for valuation
What are the two markets for valuation in fair value?
Principal mark & Most advantageous market
Define Market Participant
The buyers and sellers that are independent of the reporting entity, acting in their own best interest knowledgeable of the item or transaction and they are able and willing to enter into the transaction but are not compelled to do so
For fair value measurement - Highest and best use considers what?
Physically Possible
Legally Permissible
Financially Feasible
Define Net Asset Value (NAV) as Practical Expecient
Allowed when there is no readily available fair value - Assets less Liabilities
Examples - Investments in a company
Define an order transaction
A transaction that is not under duress, not forced liquidation
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.
Define Pervasive Applicability
the content of ASC 820 must be followed when fair value measurement is used, either as required or permitted by other pronouncements.
What criteria must be met in order to use NAV as the practical expedient?
- Does not have a readily determinable fair value
- The investment meets the criteria for an investment company as stipulated in ASC 940-10-15-2 or does not meet the criteria to be an investment company but follows industry practice and issues financial statements consistent with the measurement principles for an investment company.
What is the income approach of assessing fair value?
Using present value techniques to discount cash flow
Identify reasons why an entry price and an exit price may not be the same on the recognition date.
- The transaction is between related parties;
- The transaction takes place when the seller is under duress (e.g., in a liquidation sale);
- The unit of account for the transaction price is different from the unit of account that would be used to measure the asset or liability at fair value. For example, if the asset or liability measured at fair value is part of a business in a business combination, there are unstated rights associated with an asset that are measured separately, or the quoted price includes transaction costs, such as with oil
- The market in which the transaction price takes place is different from the principal market (or most advantageous market).
Identify when a change in techniques may be appropriate and the consequence of such a change.
A change in valuation technique or its application is appropriate if the change will result in a more representative fair value
Identify when the fair value option can be applied.
- When the item is first recognized;
- When an eligible firm commitment is established;
- Specialized accounting for an item ceases to exist;
- An investment becomes subject to equity method accounting (but is not consolidated) or to a VIE that is no longer consolidated; or
- An event that requires the item to be measured at fair value, such as a business combination or significant modifications to debt instruments.
When can the fair value option not be applied?
- An investment in a subsidiary that is to be consolidated
- An interest in a variable interest entity that is to be consolidated
- Employers’ and plans’ obligations (or assets) for pension benefits, other postretirement benefits, postemployment benefits, and other employee-oriented plans
- Financial assets and liabilities recognized under lease accounting
- Demand deposit liabilities of financial institutions
- Financial instruments that are classified by the issuer as a component of shareholders’ equity
Define Entry Price
When an asset is acquired or a liability is assumed in a transaction, the price paid to acquire the asset or the price received to assume the liability is an entry price
Define Exit Price
the price that would be received to sell an asset or paid to transfer a liability which is an exit price.
What are observable inputs in determining fair value?
Derived from market data from sources independent of the reporting entity
What are unobservable inputs in determining fair value?
Entity’s assumptions based on best information available in circumstances
Describe the three levels of the fair value hierarchy
Level 1 - The desirable level of inputs and used in determining fair value - Observable inputs for the exact same item
Level 2 - The second level desirable of inputs and valuation - inputs are directly or indirectly observable but do not meet all conditions for Level 1 - similar items
Level 3 - The lease desirable because inputs and valuations are not observable - no way to verify data - based on assumptions
Are liquidity adjustments allowed to be included in the 3 hierarchies?
- Yes
Are control premium adjustments allowed to be included in the 3 hierarchies?
- No
Are blockage discounts adjustments allowed to be included in the 3 hierarchies?
- No
Describe significant disclosures required for assets, liabilities, and equity items measured at fair value on a recurring basis.
- The fair value at reporting date
- The valuation techniques
- Inputs used in those techniques
- Table showing items at each level of the fair value hierarchy
- Transfers into and out of each level of hierarchy
- If level 3 - a reconciliation of the beginning and ending balances
- If level 3 - Description of the valuation process and significant assumptions
Describe significant disclosures required for assets, liabilities, and equity items measured at fair value on a nonrecurring basis.
- The fair value at reporting date
- The valuation techniques
- Inputs used in those techniques
- Reasons for the fair value measurement
- Level of the fair value hierarchy within which measurement
- If Levels 2 & 3 - A description of any changes in techniques
- If level 3 - unobservable - the effects of measurement on earnings or OCI
- If level 3 - unobservable - Quantitative information about the unobservable inputs used
Describe the significant disclosure requirements for the election of the fair value option applied to assets, liabilities, and equity items.
- The items for which fair value election is applied and the reason it was chosen.
- The amounts of gains and losses associated with the fair value changes
Identify the authoritative guidance for international accounting standards.
IFRS
List the IFRS Hierarchy
Level 1- IFRS and implementation guidance dealing with specific issue or similar situations
Level 2- Definitions, recognition criteria, and measurement concepts for A, L income, and expenses in the framework
Level 3- Pronouncements from other standard-setting bodies using a similar framework
Identify major differences between U.S. GAAP and IFRS.
IFRS is more principle based and less rules based
IFRS is less detailed than US GAAP
IFRS is less volume than US GAAP
IFRS has fewer rules
IFRS requires more professional judgement
IFRS has less literature to address expectations
What are the objectives of IASB
To develop a single set of high quality, understandable, enforceable and globally accepted financial reporting standards.
To promote the use and rigorous application of IFRS.
To consider the needs of a wide range of size and type of entity throughout the world
To promote and facilitate adoption of IFRS through convergence
Which standard setting board is more principles based and less rules based - US GAAP or IFRS?
IFRS
Describe the standard-setting process for the International Accounting Standards Board (IASB)
Research Programme - Research –> Discussion Paper –> Proposal
Standard Programme - Exposure Draft –> Published IFRS
Review Programme - Post-implementation review
Describe the standard-setting process for the International Accounting Standards Board (IASB)
Research Programme - Research –> Discussion Paper –> Proposal
Standard Programme - Exposure Draft –> Published IFRS
Review Programme - Post-implementation review
—————————————————————————–
1. Set agenda.
2. Plan project.
3. Develop and publish a discussion paper.
4. Prepare and vote on the exposure draft.
5. Develop and publish an exposure draft.
6. Develop and publish a standard.
7. Address unanticipated issues after the standard is issued.
Define Convergence
Refers to the working relationship between the FASB and the IASB to develop compatible, high-quality accounting standards
Identify the purpose of the conceptual framework (IFRS)
The financial information helps users assess management’s stewardship over the entity
Identify the IASB Framework’s constraints.
cost-benefit
Identify the IASB Framework’s objectives of financial statements
To be decision-useful - reports that provide information about an entity’s assets, liabilities, equity, income and expenses
Identify the IASB Framework’s Qualitative characteristics
Relevance and faithfulness representation
Comparability, verifyability, timeliness, understandability
Identify the IASB Framework’s elements
Assets, liabilities, equity, income and expenses
What are the IASB Framework’s assumptions
- The accrual method is used
2. The entity is on going
Define prudence
The exercise of caution when making judgments under conditions of uncertainty
Under IASB which financial statement is the primary source?
Income Statement
Describe the major aspects of IFRS for SMEs.
- Disclosures are simplified in a number of areas including pensions, leases and financial instruments
- Goodwill and indefinite-life intangibles assets are amortized over a period not to exceed 10 years
- A simplified difference approach to income tax accounting
- Accounting for financial assets and liabilities makes greater use of cost
- No disclosures for earnings per share and segments
Describe the presentation and content of the IFRS financial statements
IFRS balance sheet sections are upside down compared to US GAAP
Identify major differences in the reporting of the general-purpose financial statements under IFRS
IFRS has no requirement for reporting special items and GAAP does
IFS requires dividend per share disclosures and GAAP does not
IFRS permits revaluation of PPE through OCI and GAAP does not
Identify major differences in the reporting of the general-purpose financial statements under IFRS
- IFRS has no requirement for reporting special items and GAAP does
- IFS requires dividend per share disclosures and GAAP does not
- IFRS permits revaluation of PPE through OCI and GAAP does not
- IFRS allows reserves and GAAP does not
- IFRS requires comparative periods on the BS and GAAP does not
- IFRS changes in owners’ equity must be presented in a separate statement while in GAAP they could just be in the notes unless large
- IFRS allows interest, taxes and dividends to be either operating or financing while GAAP they are operating only (Dividend paid financing only)
- IFRS may include bank overdrafts GAAP does not allow
International standards suggest the following order of footnote presentation
- Statement of compliance with IFRS;
- Summary of significant accounting policies; and
- Supporting information for financial statement items.
The summary of significant accounting policies should include:
- Judgments and key assumptions made in applying those policies;
- Measurement bases used for recognition (e.g., historical cost, fair value); and
- Information enabling an assessment of the estimation uncertainty that could result in a material adjustment to the balances of assets and liabilities, which are point estimates in many cases.
The enhancing qualitative characteristics of financial reporting are
Comparability, verifiability, timeliness, and understandability.
When a parent-subsidiary relationship exists, consolidated financial statements are prepared in recognition of the accounting concept of:
Economic Entity
