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 Qualitative Characteristics of Financial Reporting?
Nemonic:
Relevance - What’s relevant to you?
- Passing Confirms Money
- Faithful representation - completely neutral is free from error
Relevance & Faithful Representation
- Relevance - Makes a difference to the user
Includes:
P - Predictive Value - Future Trends
C- Confirming Value - Past Predictions
M - Materiality - Could affect User Decisions
- Faithful Representation
Includes:
Completeness - Nothing omitted that would impact the decision-making of a user
Neutrality - Information is presented without bias
Free from Error - No material errors or omissions
What are the Enhancing Qualitative Characteristics of Financial Reporting?
Comparability Verifiability Timeliness and Understandability
Comparability - Allows users to compare different items among various periods
Verifiability - Different people would reach a similar conclusion on the information presented
Timeliness - Information is made available early enough to impact the decision making of users
Understandability - Information is easy to understand
What are the Secondary Constraints of Financial Reporting?
Consistency - Year vs. Year
Comparability - Company vs. Company
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
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)
What is recognition in accounting?
When an item is recorded and included in the financial statements
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
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?
Price quotes or market prices
For example NYSE or NASDAQ
What items are included in a Level 2 valuation input?
Interest rates
Prime rate
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 acceptable valuation techniques for fair value?
Market approach - uses market transactions and prices to value the asset
Income approach - uses present value discounts earnings
Cost approach - uses replacement cost to value the asset
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 an operating cycle?
Average time it takes to turn materials or services into Cash
What is the present value of future cash flows?
Valuation method - the current value of a future amount of money using a specific interest rate
What is historical cost?
How much an asset cost - (net of depreciation and amortization)
What is replacement cost?
How much it would cost to reacquire an asset today (Entrance Cost)
What is a market cost?
The sale price of an asset (Exit Cost)
What is Net Realizable Value?
Sale Price of an Asset - Selling/Disposal Fee
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 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 franchise revenues recorded?
Franchiser - Startup franchise fee revenue deferred until franchisee has completed substantial performance
Franchisee – Costs are deferred until corresponding revenue is recognized
How are discontinued operations reported? When are they used?
Reported Net of Tax after Continuing Operations
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
Separately classified, presented and disclosed in the footnotes. No longer presented on I/S.
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
When is interest not expensed?
Interest on projects (software) for internal use is not expensed but is instead capitalized
What are the major components of comprehensive income?
Net Income + Other Comprehensive Income (OCI):
Revenues/Expenses
Gains/Losses
Cumulative accounting adjustments
Reclassifications adjustments
Non-owner changes in equity
What items are considered cumulative accounting adjustments?
Foreign Currency Translation Adjustments
Unrealized gains on AFS Securities
Minimum Pension Liability adjustment for defined benefit plans
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 Stockholder’s Equity on Balance Sheet or in a Statement of Income and Comprehensive Income
Note: Earnings Per Share is not required for OCI
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 some major risks and uncertainties that must be disclosed?
Nature of Operations
Use of Estimates and listing of Significant Estimates
Concentration vulnerability
How should you go from Cash to Accrual accounting?
To go from cash to accrual accounting, need to take into consideration of the change in accounts
Whatever the “PLUG” figure is, it is the answer
How should you go from Accrual to Cash accounting?
When going from Accrual to Cash accounting, using the change in accounts method will NOT work
To determine cash sales, need to take total revenue and back out the accrued sales, which is the change in A/R for the year
How do you calculate Realized Income / Realized Gross Profit?
(Installment Sales formula)
Cash Collections
x Gross Profit %
= Realized Income/ Realized Gross Profit
How do you calculate Deferred Income / Deferred Gross Profit?
(Installment Sales formula)
Ending Installment A/R
x Gross Profit % (Amount of Income not collected)
= Deferred Income/ Deferred Gross Profit
What does beginning A/R represent for an Installment Sales problem?
Remember with Installment Sales, the beginning A/R balance is the “Installment sale”
Beginning A/R
- Collection on A/R for the year
= Ending A/R for the year
What do you do with interest income in an Installment Sales problem?
If interest income is included in the question, remember that all interest income is recognized immediately when the payment is received
Is interest income recognized when the Cost Recovery method is used?
Remember that we DON’T recognize interest income when using the cost recovery method
In the cost recovery method, principal and interest payments received are considered to be just a recovery of cost
How do you calculate Realized Income or Gross Profit?
(Installment Sales formula)
Net Sales (Installment sales - DO NOT use regular sales)
Less: Cost of Sales
= Realized Income / Gross Profit
How do you calculate Cash collected in an installment sale?
Beginning Installment A/R
- Ending Installment A/R
= Cash collected
How do you calculate Net Sales?
Gross sales
- Sales discount
- Sales returns & allowances
= Net sales
How do you calculate Gross Margin / Gross Profit?
Net Sales
- COGS / COS
= Gross Margin / Gross Profit
How do you calculate COGS?
Beginning Inventory
+ COG Purchased [Purchases + Freight-in + Transportation costs]
= COGAS
- Ending Inventory
= COGS
How do you calculate COG Purchased?
Gross Purchases
- Purchase discount
- Purchase returns & allowances
= Net Purchases
+Freight-IN or Transportation-IN
= COG Purchased
How do you calculate Operating Income / Operating Profit / EBIT?
Gross Margin / Gross Profit
- Operating expense
= Operating Income / Operating Profit / EBIT
How do you calculate Operating expense?
Selling expense
+ G&A expense
+ R&D expense
+ Org/pre-opening costs
+ Impairment loss (for SEC registrants)
= Operating expense
How do you calculate Income from continuing operations BEFORE taxes?
Operating Income / Operating Profit / EBIT
+ Other revenues/gains
- Other expenses/losses
= Income from continuing operations BEFORE taxes
How do you calculate Income from continuing operations NET of tax?
Income from continuing operations BEFORE taxes
- Income tax expense (Current + Deferred)
= Income from continuing operations NET of tax
How do you calculate Net Income?
Income from continuing operations NET of tax
+/- Discontinued Operations (net of tax)
+/- Extraordinary gains/losses (net of tax)
= Net Income
How do you calculate Total Comprehensive Income?
Net Income
+/- Other Comprehensive Income (net of tax)
= Total Comprehensive Income
NOTE: Need to list each of the comprehensive income items net of tax
What section does an impairment loss go on the income statement if a company is NOT a publicly traded company?
If an entity is NOT a publicly traded company, the impairment loss goes under Other Expenses + Losses
If the entity IS a publicly traded company, then the impairment loss would go in the Operating Expenses category on the I/S
What items are NEVER considered to be extraordinary?
The following items are NEVER extraordinary:
- Foreign currency devaluation
- Effects of a strike
- Write-downs of assets - Inventory, A/R, PP&E, goodwill & intangibles
What are the Other Comprehensive Income items?
The following are Other Comprehensive Income items:
- Reclassification adjustments
- Unrealized holding gain/loss of AFS debt securities
- Pension or Other Post-retirement Benefit adjustments
- Unrealized holding gain/loss (effective portion only) on derivatives held as cash flow hedges, including foreign currency hedges as cash flow hedges
- Cumulative foreign currency translation adjustment (Current Rate Method)
Note: In regards to #2 above, if a company elected the fair value method, then unrealized holding gains/losses of AFS securities would be reported in Other Revenue/Gains in the multi-step I/S. If NOT, these are reported as OCI items AFTER net income
Note: In regards to #4 above, the ineffective portion would be shown in Net Income
With constant dollar accounting, what does it mean to have a Net Monetary asset position?
With constant dollar accounting, if you have a Net Monetary asset position = purchasing power loss
This is because a dollar one year from now will be able to buy less goods than a dollar today due to inflation
With constant dollar accounting, what does it mean to have a Net Monetary liability position?
With constant dollar accounting, if you have a Net Monetary liability position = purchasing power gain
This is because a dollar paid on a liability owed a year from now is worth less than a dollar paid today due to inflation
How do you calculate the conversion factor?
(Constant Dollar Accounting formula)
Current Price CPI
/ Base Year CPI
= Conversion Factor
Note: Multiply the conversion factor by the Nonmonetary Assets to arrive at the amount that should be shown in the supplementary information report
