Module 2 Study Guide Flashcards
Financial Accounting
Financial accounting is the process of preparing financial statements that companies’ use to show their financial performance and position to people outside the company, Including investors, creditors, suppliers, and customers.
Identify the 3 Major Steps in the Accounting Process
- Observe, identify, & measure events
- Record, classify, & summarize measurements
- Report economic events & interpret financial statements
Who are the various users of financial statements & for what purpose?
bank officials, investors, management, stockholders, owners, creditors, suppliers, employees, unions, customers, and government units
What are the 4 basic assumptions of GAAP?
Accounting Entity: assumes that the business is separate from its owners or other businesses. Revenues and expenses should be kept separate from personal expenses.
Going Concern: assumes that the business will be in operation indefinitely. This assumption validates especially the carrying value of assets and liabilities. In cases when liquidation is certain, this assumption is not applicable.
Monetary Unit Principle: assumes a stable currency is going to be the measurement unit of record. The FASB accepts the nominal value of the U.S. dollar as the monetary unit of record unadjusted for inflation for U.S.-based companies. This is also known as the stable dollar principle.
Time-period Principle: implies that the economic activities of an enterprise can be divided into artificial time periods.
What are the 4 basic GAAP principles?
Historical Cost Principle: requires companies to account and report based on acquisition (original) costs rather than fair market value for most assets and liabilities.
Revenue Recognition Principle: requires companies to record when revenue is (a) realized or realizable AND (b) earned, not when cash is received or when an order is received. Also, under this principle a company should establish an allowance for bad debts accounts. This way of accounting is called accrual-based accounting for both the recognition of revenues and expenses.
Matching Principle: Expenses have to be matched with revenues as long as it is reasonable to do so. Expenses are recognized not when the work is performed, or when a product is produced, but when the work or the product actually makes its contribution to revenue. Only if no direct connection with revenue can be established, cost may be charged as expenses to the current reporting period (e.g., office salaries and other administrative expenses).
Full Disclosure Principle: Amount and kind of information disclosed should be decided based on cost-benefit or after trade-off analysis as a larger amount of information costs more to prepare and use. Information disclosed should be enough to make a judgment while keeping costs reasonable. Information is presented in the main body of financial statements, in the notes, or as supplementary information.
What are the 5 basic constraints of GAAP?
Objectivity Principle: the company financial statements provided by the accountants should be based on objective evidence.
Materiality Principle: the significance of an item should be considered when it is reported.
Consistency Principle: the company uses the same accounting principles and methods from year to year.
Conservatism Principle: when choosing between two solutions, the one that will be least likely to overstate assets and net income, or understate liabilities and net losses.
Cost-Benefit Relationship: the company considers the costs necessary to prepare the information and what benefit users will get from it in making decisions, for example, about voluntary financial statement disclosures.
What are the key differences & similarities between GAAP & IFRS?
A major difference between GAAP and IFRS is that GAAP is rules-based, whereas IFRS is principles-based. With a principles-based framework, there is the potential for different interpretations for the recording of similar transactions, which could lead to extensive disclosures in the financial statements although, the standards setting board in a principles-based system can clarify areas that are unclear. This could lead to fewer exceptions than under a rules-based framework.
The methodology used to assess an accounting treatment is also different. Under GAAP, how to record a transaction is focused on a review of the rules-based literature, whereas under IFRS, a review of the facts surrounding the transaction and how they relate to the accounting principle drives how the transaction is recorded.
Describe the content & purpose of each of the 4 basic financial statements
The financial statement that reflects a company’s profitability, over a period of time, is the income statement.
The statement of stockholders’ equity explains the changes in capital stock and retained earnings between two balance sheet dates.
The balance sheet reflects a company’s solvency and financial position at a point in time.
The statement of cash flows shows the cash inflows and outflows for a company over a period of time.
GAAP Basic Objectives
Financial reporting should provide information that is:
useful to present to potential investors and creditors and other users in making rational investment, credit, and other financial decisions.
helpful to present to potential investors and creditors and other users in assessing the amounts, timing, and uncertainty of prospective cash receipts including future cash flows.
about economic resources, the claims to those resources, and the changes in them.
helpful for making financial decisions.
helpful in making long-term decisions.
helpful in improving the performance of the business.
Name a form that is generally included among the basic financial statements?
Balance Sheet
What can be found on a balance sheet?
The financial position of a business at a specific point in time
What is the primary reason a bank would be interested in a company’s financial statements?
To evaluate the company’s ability to apply for a line of credit
Which financial statement shows the profitability of a company over a period of time?
income statement
Name a step in the accounting process
Observe, identify, and measure events.
What is the fundamental contribution of the Financial Accounting Standards Board (FASB)?
Establishes generally accepted accounting standards for publicly traded companies.
