Financial Reporting Mechanics Flashcards
LOS 22. a: Describe how business activities are classified for financial reporting purposes.
Business activities are classified as operating activities if they are part of a firm’s ordinary business
Investing activities if they involve buying or disposing of long-term assets, or;
Financing activities if they are to issue or repay debt, issue or repurchase stock, or pay cash dividends
LOS 22. b: Explain the relationship of financial statement elements and accounts, and classify accounts into the financial statement elements.
Transactions are recorded in accounts that form the financial statement elements:
Assets – the firm’s economic resources
Liabilities – creditors’ claims on the firm’s resources
Owners’ equity – paid-in calital (common and preferred stock), retained earnings, and cumulative other comprehensive income.
Revenues – sales, investment income, and gains.
Expenses – cost of goods sold, selling and administrative expenses, depreciation, interest, taxes, and losses.
LOS 22. c: Explain the accounting equation in its basic and expanded forms. Basic.
Basic accounting equation
Assets = liabilities + Owners’ equity
LOS 22. c: Explain the accounting equation in its basic and expanded forms. Expanded.
Expanded accounting equation
Assets = liabilities + contributed capital + ending retained earnings
LOS 22. c: Explain the accounting equation in its basic and expanded forms. Super expanded.
The super expanded accounting equation:
Assets = liabilities + contributed capital + beginning retained earnings + revenues - expenses - dividends
LOS 22. d: Describe the process of recording business transactions using an accounting system based on the accounting equation.
Keeping the accounting equation (A – L = E) in balance requires double entry accounting, in which a transaction is recorded in at least two accounts. An increase in an asset account, for example, must be balanced by a decrease in another asset account or by an increase in a liability or owners’ equity account.
LOS 22. e: Describe the need for accruals and valuation adjustments in preparing financial statements.
A firm must recognize revenues when they are earned and expenses when they are incurred. Accruals are required when the timing of cash payments made and received does not match the timing of the revenues or expense recognition on the financial statement.
LOS 22. f: Describe the relationship among the income statement, balance sheet, statement of cash flows, and statement of owners’ equity.
The balance sheet shows a company’s financial position at a point in time.
Changes in balance sheet accounts during an accounting period are reflected in the income statement, the cash flow statement, and the statement of owners’ equity.
LOS 22. g: Describe the flow of information in an accounting system.
Information enters an accounting system as journal entries, which are sorted by account into a general ledger. Trial balances are formed at the end of an accounting period. Accounts are then adjusted and presented in financial statements.
LOS 22. h: Describe the use of the results of the accounting process in security analysis.
Since financial reporting requires choices of method, judgement, and estimates, an analyst must understand the accounting process used to produce the financial statements in order to understand the business and the results for the period. Analysts should be alert to the use of accruals, changes in valuations, and other notable changes that may indicate management judgment is incorrect or, worse, that the financial statements have been deliberately manipulated.
