Financial Reporting Flashcards
What is the primary objective of accounting?
To measure income
What is the most authoritative set of accounting pronouncements?
The FASB Codification
All pronouncements fall under the Codification umbrella
What are the 2 Levels of Authority within the FASB codification?
Authoritative and Non-Authoritative
How does managerial accounting differ from financial accounting?
Managerial Accounting has a timeliness focus
Managerial Accounting is not required to follow GAAP
Which financial reports are required to be filed with the SEC?
Form 10K - Annual and Audited
Form 10Q - Quarterly and Reviewed
What is the focus of financial reports for individual companies?
Focus is on the needs of users to help them make decisions and assessments about the company
Does not make assessments of the economy
What are the Primary Constraints of Financial Reporting?
Cost vs. Benefit
Materiality
What are the Secondary Constraints of Financial Reporting?
Consistency - Year vs. Year
Comparability - Company vs. Company
What are the Primary Qualitative Characteristics of Financial Reporting?
Relevance & Faithful Representation
Relevance - Makes a difference to the user
Includes: “PC”
Predictive Value - Future Trends
Confirming Value - Past Predictions
Materiality - Could affect User Decisions
Faithful Representation
Includes:
Free from Error - No material errors or omissions
Neutrality - Information is presented is without bias
Completeness - Nothing omitted that would impact the decision-making of a user
Roger is never on the “FENCe”
What are the Enhancing Qualitative Characteristics of Financial Reporting?
Comparability, Verifiability, Timeliness, and Understandability
Comparability - Allows users to compare different items among various periods
Understandability - Information is easy to understand
Timeliness - Information is made available early enough to impact the decision making of users
Verifiability - Different people would reach a similar conclusion on the information presented
“CUT” like a “V”
How does Conservatism affect the recording of accounting transactions?
When an estimate is necessary due to uncertainty, conservatism chooses the best option that won’t overstate the financial position of the company
Must consider all risks inherent in the business
What is an accrual?
Earned (Revenue) or Incurred (Expense) but no Cash Receipt/Outlay yet
What is a deferral?
Cash Receipt/Outlay but not Earned (Revenue) or Incurred (Expense)
Describe fair value with respect to an asset
The price you would receive if you sold the asset
Assumes asset is at its highest and best value
Assumes asset is sold at its most advantageous market to get the best price possible (maximizes the price received for the asset, or minimizes the amount paid to transfer the liability)
What market assumptions are made in a fair value assessment?
Buyer and Seller are not Related
Buyer and Seller are Knowledgeable
Buyer and Seller are able to transact - i.e. This isn’t a hypothetical transaction for Fair Value measurement purposes. The buyer actually does have the $10M to purchase the asset you’re trying to value at $10M
Buyer and Seller are both motivated to buy/sell
What items are included in a Level 1 input in the fair value hierarchy?
Quoted Prices from active markets
For example NYSE or NASDAQ
What items are included in a Level 2 valuation input?
Directly or Indirectly observable inputs (other than level 1)
Interest Rates, Prime Rates, Credit Risks, etc
What are acceptable valuation techniques for fair value?
If there is a change in technique, what is this considered?
Market approach - uses market transactions and prices to value the asset
Income approach - uses present value techniques to discount cash flows or earnings
Cost approach - uses replacement cost to value the asset
“MIC”
A change in technique is considered a change in estimate
What items are included in Level 3 inputs of the fair value hierarchy?
Unobservable inputs such as assumptions or forecasts
Lowest priority for valuation
What are current assets?
Cash
Inventory or Assets expected to be converted or consumed during a business’ operating cycle
Deferred Gross Profit on Installment Sales (Contra Asset)
Receivables expected to be collected in 12 months or less
What are current liabilities?
Liabilities that will use current assets during the present operating cycle
What is an accrued liability?
Expense that has been incurred but not paid
Example: rents payable
What is a deferred revenue?
A type of current liability
Payments that have been received but cannot be recorded as revenue yet
Example: Tenant pre-pays rent - Landlord still must perform to earn it and is a liability until this happens
When are revenues recognized?
When they have been earned; i.e. company has performed
What is a gain?
Increase in equity from an activity or event that is not central to the main activities of the business
Can be operating or non-operating
What is a loss?
Decrease in equity from an activity or event that is not central to the main activities of the business
Can be operating or non-operating
What is the present value of future cash flows?
What factors must be considered?
The current value of a future amount of money using a specific interest rate
-Risk: Probability that the cash will actually be paid
-Timing: Periods in which the payments are expected to be received
-Interest Rate
-Amount of CF:
-Traditional Approach: Most likely CF amount
- Expected Approach: Use Weight. Avg of
different possibilities
(10%x$100)+(60%x200)+(30%x$300)=$220
If measuring a liability- must consider credit of other entity.
What is an operating cycle?
Average time it takes to turn materials or services into Cash
What is historical cost?
How much an asset cost - (net of depreciation and amortization)
What is a market cost (fair market value)?
The sale price of an asset or to transfer a liability (Exit Cost)
What is Net Realizable Value?
Sale Price of an Asset - Selling/Disposal Fee
amount expected to be converted to A/R
What is replacement cost?
How much it would cost to reacquire an asset today (Entrance Cost)
When is royalty income recognized? How is it recognized?
Recognized when earned
If the royalty % is applied against net sales then subtract the estimated return amount from the gross sales first and then apply the royalty rate
When is revenue recognized in an installment sale?
Revenue recognized upon receipt of cash
Only used when cash collection is uncertain
What is deferred gross profit?
Gross Profit that can’t be recognized until cash is received
D.GP : Gross Profit % x Accounts Receivable
Pay attention to the year if GP% varies
What is the cost recovery method?
No revenue recognized until all costs are recovered from purchase of the asset
Most conservative method of revenue recognition when collection of sale price is uncertain
What is subscription revenue? How is it recorded?
Payment has been received but performance is not complete.
As company performs revenue is recognized.
Recorded as a Deferred Revenue (Liability) on Balance Sheet
How are franchise revenues recorded?
Franchisor - Startup franchise fee revenue deferred until substantial performance
Franchisee - Costs are deferred until corresponding revenue is recognized
How do you calculate sales revenue starting from cash basis income?
Mnemonic: SPEAR-BAR
Sales (i.e. Customer Payments)
+ Ending Accounts Receivable
- Beginning Accounts Receivable
: Sales Revenue on an Accrual Basis
How do you calculate COGS starting from Cash Basis?
Mnemonic: CRAP-I
Cash Remitted (i.e. paid)
+Increase in Accounts Payable
-Increase in Inventory
:COGS on an Accrual Basis
How are discontinued operations reported? When are they used?
Reported Net of Tax after Continuing Operations but before Extraordinary Items
Company decides to cease operating a segment of its business
Includes Income (or loss) from the period plus the gain (or loss) from disposal
What qualifies as an extraordinary item? How is it recorded?
Both unusual AND infrequent
Reported Net of Tax after Discontinued Operations
Note: Usual or Infrequent Items are reported as part of Continuing Operations
What is constant dollar accounting?
Adjusts assets to reflect a consistent level of purchasing power due to inflation
Uses the Consumer Price Index (CPI)
When are expenses recognized?
When they are incurred. Accrue if not yet paid.
What are accrued expenses?
Those incurred but not paid.
Product costs - Expenses should be matched with associated revenues as they are recognized (sales commission on a used car sale)
Period costs - Expenses amortized and recognized with the passage of time
When should impaired assets be written down to fair value and expensed?
Immediately.
What major items should be classified under General & Administrative (G&A) expenses?
Office staff salaries
Office/building rent
Office supplies
Note: Sales staff salaries and portions of the building assigned to Sales should be allocated to Selling Expense not G&A
What are business start-up costs?
One-time costs for opening a new business
Expensed as they are incurred
What are the major components of Comprehensive Income?
“all other changes in equity other than the owner sources”
Net Income + Other Comprehensive Income (OCI):
Revenues/Expenses
Gains/Losses
Cumulative accounting adjustments (DENT)
Reclassifications adjustments
Non-owner changes in equity
What items are considered cumulative accounting adjustments included in comprehensive income?
Derivative cash flow hedges
Excess adj. of Pension PBO and FV of Plan Assets
Net unrealized gains or losses of AFS securities
Translation adjustments for foreign currency
“DENT”
When is interest not expensed?
Interest on projects (software) for internal use is not expensed but is instead capitalized
What is the purpose of a reclassification adjustment?
Avoids double counting items that were included in both Net Income and OCI
Example: AFS Securities previously included in OCI are now sold at a loss and reported on the Income Statement
Where is Comprehensive Income reported?
Reported in a Single or Combined Income Statement
What are some major risks and uncertainties that must be disclosed?
Nature of Operations
Use of Estimates and listing of Significant Estimates
Concentration vulnerability (customers, vendors)
What disclosures on accounting policies are required in financial statements?
Accounting Principles used
Basis of Consolidation
Inventory Pricing Methods
Depreciation Method
Amortization of Intangibles
What are the Objectives of financial reporting?
- Provide useful info to existing and potential investors, lenders, and other creditors for decision making
- Determine the entity’s economic resources and claims
- Changes in economic resources and claims
- Financial performance reflected by accrual acctg
- Financial performance reflected by cash flows
- Changes in economic resources and claims, not resulting from financial performance (issuing additional stock,etc)
Equity consist of 3 elements:
Contributions by Owners
Distributions to Owners
Comprehensive Income —> “DENT”
What does matching mean in financial reporting?
Recognize a cost as an expense in the same period as the benefit (usually a revenue) is recognized
What does Realization mean in financial reporting?
Converting non-cash resources into cash or a claim to cash
When can you recognize a financial statement element and how do you measure it?
- Meets the definition of an element
- Element is capable of being measured in monetary terms
- The items is relevant and useful (faithful repres)
6 Steps to apply the fair value measurement approach:
- Identify the asset/liability to be measured
- Determine “Principal” or “Most Advantag. Mkt”
- Determine Valuation Premise (in-use or in-exchange)
- Detemine Valuation Technique (MIC)
- Obtain Inputs for Valuation (Level 1,2,3)
- Calculate the FV
Electing Fair Value to Measure Assets / Liabilites characteristics:
- Elect to measure at FV on date the item is first recognized
- Election is irrevocable
- Can be made on an instrument by instrum. basis
- Unrealized Gains/Losses reported in earnings
Based on revenue recognition, a revenue is recognized when:
- A binding arrangement exists (signed contract)
- Services rendered or delivery has occured
- Fixed or Determinable price exists
- Collection is reasonably assured
Recognized expenses or losses when:
Economic benefit is used up (consumed) or assets lose future benefits
- Cause and Effect: expenses that produce revenue at identifiable points in time can be matched directly to revenue
- Systematic and Rational Allocation: Expenses that produce revenue over long periods of time are matched to those using a resonable means of allocation (eg. depreciation)
- Immediate Recognition: when not directly related to revenue (SGA) recognize immediately
Formula to Calculate Operating Income
Sales -COGS ----------- Gross Margin - SG&A ----------- Operating Inc
Formula to calculate COGS
Beg Inventory \+ Purchases ----------------- =Goods Available for Sale - Ending Invent ------------------ COGS
Multiple Step Income Statement Presentation:
Operating Income Nonoperating Income Taxes -------------- Income From Op. Incom Discontinued Operations Extraordinary Gains/Losses -------------- Net Income \+/- OCI (DENT) ------------- Comprehensive Income
“ON the TIDE N OC”
How to report Discontinued Operations in the I/S:
Gain or Loss is reported net of taxes with disclosure of the tax effect on the fact of the Income Statement
The income statement must be adjusted retroactively to enhance comparability with the current year’s income for all prior year’s presented.
What are extraordinary gains/losses and who are they reported on the F/S?
If transaction is Unusual in nature, Infrequent of Occurrence, AND Material = extraordinary gain/loss
Reported after continuing operations and must be shown net of taxes, with the tax effect disclosed on the face of the F/S
When the Installment Method has been considered an acceptable method in which to report income, how much is recognized each period?
Income is recognized each period is the cash collected in the period multiplied by the gross profit percentage on the sale.
What are the 2 methods of accounting for long-term construction contracts? When are each recommended to be used?
- Percentage of Completion Method - recommended when collection is assured and when costs to complete the contract and estimates of progress toward the completion are reasonably dependable
- Completed Contract Method - recommended when collections are not as assured and when costs are not as easily determinable.
Percentage of Completion Method
- Profit is recognized in each period of the contract.
- The amount to recognize is determined based on the accrual basis taking into account the estimated profit on the contract, the portion of the contract that is complete, and any profit that has been previously recognized.
-More consistent with the revenue recognition principle (matching)
Completed Contract Method
- Report no profit until the job is finished (violates matching)
- Considered inappropriate unless: % of completion cannot be determined or total costs cannot be estimated
What Method does IFRS allow for Long Term Construction Contracts?
Percentage of Completion Method
If the Percentage of Completion is not able to be determined then revenue should be recognized using the cost recovery method.
Cost recovery method recognizes revenue only to the extent that the expenses are recoverable.
IFRS does NOT allow the Completed Contract Method.
What are examples of items that are NOT considered extraordinary items because they are not BOTH unusual AND infrequent?
a. Write-down or write-off of receivables, inventories, equipment leased to others, or intangible assets
b. Gains or losses from the exchange or translation of foreign currencies, including those relating to major devaluations and revaluations
c. Gains or losses on the disposal of a segment of a business (discontinued operations)
d. Other gains or losses from the sale or abandonment of property, plant, or equipment used in the business
e. Effects of a strike, including those against competitors and major suppliers
f. Adjustments of accruals on long-term contracts
What is included in OCI? Where is OCI listed on the Income Statement?
OCI includes revenues, expenses, gains, losses that are excluded from net income (not realized yet)
—-> DENT
Derivative cash flow hedges
Excess adj. of Pension PBO and FV of Plan Assets
Net unrealized gains or losses of AFS securities
Translation adjustments for foreign currency
OCI is included in the I/S after net income
