Friday Intermediate Flashcards
3 most common reasons for making accounting changes
Inventory Changing, human error, accounting estimates change (depreciation, bad debts, deferreds, warranty,.
What are the types of accounting changes and describe what kind of approaches are used to correct them
Accounting principle use retrospective (inventory types, retrospective–except for when changing to LIFO because LIFO inventory consists of layers added in prior years at costs existing in those years)
Change in Reporting Entity uses the retrospective approach. Examples are combinations of businesses a parent company shows collectively on its financial statements in the consolidated financial statements.
What are the most common big estimate changes? What kind of approach is used?
Uncollectible accounts like bad debt expense
Obsolete Inventory–out osf stylem damaged, no longer sellable. The company estimates disposition value for the obsolete items and subtracts estimate from the book value of the inventory.
Tangible asset (fixed asset) and depreciation–determining how long the company will be able to use an asset and the salvage value of the asset.
Deferred Cost are the costs that show up on the balance sheet as an asset until it’s time to move them to the income statement as an expense
Servicing warranties: When a company sells a product with a warranty or performance guarantee, it recognizes the estimated cost of servicing the warranty in the same financial period in which the revenue from the sale is booked.
USE THE PROSPECTIVE APPROACH
What kind of approach does depreciation have and why?
Prospective. Even though it may be a change in principle (via a different method), it is also a change in estimate.
When these two ideas intersect, we use the change estimate.
Define changing something retrospectively and what kinds of things use this approach?
a restatement of financials that requires an adjustment of prior years’ financials.
Why is LIFO accounted for differently than the other types of changes in accounting principle?
LIFO consists of layers added in prior years at costs existing in those years. If another method has been used, though, the company likely hasn’t kept track of those costs. Therefore, the accounting records of prior years usually are inadequate to report the change retrospectively. In this case a company changing TO LIFO reports the change prospectively and the beginning inventory becomes the base year of inventory for all future LIFO calculations.
A disclosure note should indicate why didn’t use the retrospective applicaiton
What are the exceptions to retrospective applications
when authoritative literature requires prospective applications, switching TO LIFO, or when full retrospective application isn’t possible.
What is counterbalance in Inventory errors and why is it significant?
IF an error naturally corrects itself over two financial period, accounting management of a company may decide not to take action.
EX:
Example: Errors with respect to inventory.
(1) If the books have been closed:
(a) No entry necessary, if error already counterbalanced.
(b) If error not yet counterbalanced, need entry to adjust retained
earnings.
(2) If the books have not been closed:
(a) If error already counterbalanced and company is in second year, need entry to adjust the beginning retained earnings balance and to correct the current year.
(b) If error not yet counterbalanced, also need entry to correct beginning retained earnings balance and correct the current period.
In errors, what are we really worried that it affected?
Likely retained earnings.
In the accrual method: When do we record revenues and expenses?
What is the missing piece when using the accrual method of accounting?
When they are earned and realizable (when they are incurred).
The missing piece is the cash flows… what is the effect on business operations when cash changes hands.
What is the purpose the cash flow statement:
Gives use r information about cash payments of the business during the accounting period.
3 Sections of cash flows
Operating: sources and uses that come from revenue, expenses, gains, losses, and other costs. INTEREST OF LOAN PAYMENTS
Investing: Sources and uses of cash from debt and equity purchases of another company and sales of those, purchases of property, plant, and equipment, and collection of principal on debt.
Financing: long-term liability… issuing debt and equity items, payment of dividends, treasury stock transactions… PRINCIPAL PAYMENTS ON CAPITAL LEASE OBLIGATIONS ARE FINANCING ACTIVITIES (because a capital lease is when the renter assumes all the benefits and liabilities of ownership)
Difference between direct and indirect method of cash flows
Direct: only reporting components of the income statement that represents increases or decreases in cash. FASB-preferred.
Indirect: start with net income (which includes both cash and non-cash components) and back out all amounts that don’t reflect increases or decreases in cash
In cash flows, dividends are____ and interest is _____
dividends are financing and interest is operating.
A dividend is assumed to be for ______________ unless it specifically states ____________
assumed to be for common stock holders unless it says preferred
