TEST ONE Flashcards
Ch. 1, 2, 3, 4, & 5
definition
Accounting
the process of identifying, measuring and communicating financial information about economic entities to permit informed judgments and decision by users of information
definition
Generally Accepted Accounting Principles (GAAP)
a set of principles decided by FASB to provide the most useful information at the least cost to a wide variety of reasonably informed users, so they can make good decisions (make sure the information is presented fairly, clearly, and completely)
definition
Conceptual Framework
a coherent system of interrelated objectives and fundamental concepts that prescribes the nature, function, and limits of financial accounting and reporting (expected to lead to consistent guidance)
Hierarchy of GAAP Standard Setting Authority
- Congress
- SEC
- CAP, APB, FASB
FASB is the only active organization (1973 to now)
what it stands for/years active
CAP
Committee on Accounting Procedures; they issued accounting research bulletins; 1939-1959
APB
Accounting Principles Board; released APB opinions; 1959-1973
FASB
Financial Accounting Standards Board; they issue accounting standards updates; 1973 to now
Organization of the FASB
Financial Accounting Foundation (FAF) appoints and funds:
* Financial Accounting Standards Board (FASB)’s 7 members
* Financial Accounting Standards Advisory Council (FASAC) approx. 35 members
definition and purpose
SEC
Securities Exchange Commission; established by Congress to oversee the organized stock exchanges; has the power to establish and enforce accounting standards for public companies
What does FASB issue to update GAAP?
FASB issues Accounting Standards Updates
Steps the FASB takes in the creation of a financial accounting standards update:
- Research
- Public hearing
- Exposure draft
- Accounting standards update
Titles of relevant statements of financial accounting concepts
there’s four of them
- objectives
- qualitative characteristics
- elements
- recognition and measurement
Objectives should provide information about the reporting entity:
- useful to existing/potential investors, lenders, etx, in making decisions about providing resources to the entity
- to help present/future investors, lenders, etc. assess the amount, timing, and uncertainty of future cash inflows of the entity
- about the resources of the entity, claims against the entity, and how efficiently jobs are divided up so that objectives 1&2 can be satisfied
Qualitative Characteristics include:
- objective
- constraint
- pervasive criterion
- fundamental qualities
- enhancing qualities
Ingredients of fundamental qualities:
Relevance or Faithful Representation
one of two fundamental qualities
Relevance
definition of relevance
to be relevant, accounting information must be capable of making a difference in a decision
one of two fundamental qualities
Faithful Representation
definition of faithful representation
correspondence between numbers or descriptions and events they represent
relevance is one of two fundamental qualities
ingredients of relevance
- predictive value=forecast the outcome of past, present, and future events
- confirmatory value=confirm or correct prior expectation
- materiality=an item is material if its inclusion or omission would influence or change the decision of a user of the financial information
faithful representation is one of two fundamental qualities
ingredients of faithful representation
- completeness=all of the information necessary for faithful representation is provided
- neutrality=absence of bias
- free from error=no errors or omissions in the description of the financial information (doesn’t imply total freedom from error)
Enhancing qualities include:
- comparability=consistency in accounting treatment
- verifiability=occurs when there’s a consensus among independent observers
- timeliness=available before losing capacity to influence the decision
- understandability=allows reasonably informed users to gain significance of information
Elements of financial statements
measured as point in time (assets, liabilities, equity)
measured over a period of time (investments by owners, distributions to owners, comprehensive income, revenues, expenses, gain, losses)
first 3 are changed by the following 7 (inter-relation=articulation)
Recognition and measurement
four basic assumptions and 4 basic principles
4 basic assumptions
- economic entity assumption
- going concern assumption
- monetary unit assumption
- time period assumption
definition
economic entity assumption
4 basic asssumptions
distinguish each organization from its owner and any other business unit
definition
going concern assumption
4 basic assumptions
the business will continue to run indefinitely unless there’s evidence to the contrary
definition
monetary unit assumption
4 basic assumptions
the common denominator is money; assumes stability
definition
time period assumption
4 basic assumptions
divide economic activities into arbitarary time periods to make current evaluations of operations (ex: monthly, quarterly, yearly)
4 basic principles
- measurement principle
- revenue recognition principle
- expense recognition (matching) principle
- full disclosure principle
definition
measurement principle
4 basic principles
the basis on which amounts in the financial statements are determined; two measurement bases:
1. historical cost=transactions measured at the acquisition price
2. fair value=the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date
definition
revenue recognition principle
4 basic principles
revenue should be recognized by a company in the accounting period in which it has satisfied its agreement with the customer to provide a good/service
definition
expense recognition (matching principle)
4 basic principles
expenses should be matched with revenue or recorded in the same accounting period as the revenue that was earned through that expense
definition
full disclosure principle
4 basic principles
provide all information necessary to present a complete picture of the performance and position of the company (the info may be qualitative or quantitative and in one of three places: within the body of financial statements, in the notes to the financial statements, or as supplementary information)
definition
general ledger
a book containing the entire group of accounts for the company; each account is on a separate page and usually assigned an account number
definition
posting (to the ledger)
the process of transferring the totals from the journals to the individual accounts in the ledger and the sub-accounts in the subsidiary ledgers
definition & purpose
subsidiary ledger
a group of sub-accounts that in total equal the primary (control) account in the general ledger; (purpose is to organize the detail items comprising the control account in the general ledger and to free the general ledger of the volume of detail)
definition & purpose
trial balance
a list of all the accounts in the ledger and their debit or credit balances at the end of the period; (purpose is to test the accuracy of the postings to the ledger by determining if the general ledger is in balance; debits=credits)
DOES NOT prove that there are no errors in the individual acc. balances
definition
adjusting journal entries
the mechanism by which an accrual basis (as opposed to cash basis) is achieved; only prepaid items & accrued items require adjusting entries!
definition & explanation
time-period assumption
the economic activities of a company are divided into artificial time periods (monthly, quarterly, yearly); (most accurate way to measure the results of a company’s activities would be to measure them at the time of the company’s eventual liquidation, however, management, investors, creditors, and other interested parties can’t and won’t wait indefinitely for that information)
this is why the life of the company is broken into smaller units called accounting periods!
definition
cash basis of accounting
revenues are recorded in the period when cash is received and expenses are recorded in the period when cash is paid
cash basis IS NOT GAAP!
definition
accrual basis of accounting
revenues are recorded in the period when they are earned & expenses are recorded in the period when they are incurred to earn that revenue, without regard to the time of receipt or payment of cash
accrual basis IS GAAP!
definition
revenue recognition principle
revenues are recorded in the accounting period when they are earned (the period in which the goods were sold or the services performed), without regard to the time of receipt of cash
definition
expense recognition (matching) principle
expenses are recorded (matched) in the same accounting period as the revenues that they helped to generate, without regard to the time of payment of cash
definition & examples
prepaid (deferred) items
items for which the cash part of the transaction came early
either: cash was received before the revenue was earned (unearned revenue) OR cash was paid before the expense was incurred (prepaid assets, buildings, equipment)
definition & examples
accrued items
items for which the cash part of the transaction came late
either: cash was received after the revenue was earned (receivable) OR cash was paid after the expense was incurred (payable)
definition
closing entries
are posted to the appropriate general ledger accounts; revenue, expense, and dividend accounts are all closed to retained earnings!
definition
the post-closing trial balances
final trial balance that ensures that all the closing entries were recorded correctly
there should be balances only in the balance sheet accounts since the balances in all the revenue, expense, and dividend accounts should be zero after closing to retained earnings!
definition
reversing entries
the exact opposite of the adjusting entry made in the previous period
finish the blank
cash basis of accounting; revenue is recognized…
when cash is received
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cash basis of accounting; expense is recognized…
when cash is paid
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cash basis of accounting; timing of payment…
is critical
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cash basis of accounting; OK for GAAP?…
no
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cash basis of accounting; adjusting entries?
no
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cash basis of accounting; advantages…
easy, fast
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cash basis of accounting; disadvantages…
revenue recognition & matching principles are violated!
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accrual basis of accounting; revenue is recognized…
when revenue is earned
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accrual basis of accounting; expense is recognized…
when matched with related revenue
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accrual basis of accounting; timing of payment…
is irrelevant
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accrual basis of accounting; OK for GAAP?
yes
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accrual basis of accounting; adjusting entries?
yes
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accrual basis of accounting; advantages…
better indication of actual performance
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accrual basis of accounting; disadvantages…
more complicated
remember!
adjusting entries are required because…
of the revenue recognition principle & the matching (expense) principle!
types of accounts used in adjusting entries…
- prepaid asset/expense
- unearned revenue/revenue
- payable/expense
- receivable/revenue
1&2 are prepaid (deferred) items; 3&4 are accrued items!
3 steps in preparing closing entries…
- transfer credit balances from revenue accounts to retained earnings
- transfer debit balances from expense accounts to retained earnings
- transfer dividend account balance to retained earnings
3 steps in preparing adjusting entries FOR PREPAID ITEMS…
- determine what the account balance currently is for the prepaid item by referring to the original entry that was made at the time when the cash was received or paid
- determine what the account balances should be at the end of the period
- prepare an adjusting entry for the difference between what the balance currently is & what it should be
3 steps in preparing adjusting entries FOR ACCRUED ITEMS…
- recognize that since no cash has been received or paid & that since cash is the normal sign to record a transaction, no entry has yet been made to record the event (ie no orig. JE)
- determine what the account balances should be at the end of the period
- prepare an adjusting entry for the difference between what the balance currently is (zero) & what it should be
remember!
when the original entry is made to an ASSET account…
there is NO reversing entry!
remember!
when the original entry is made to an EXPENSE account…
there IS a reversing entry!
