U.S. GAAP Concepts & Framework Flashcards
What is the primary objective of accounting?
To measure income
What are the underlying assumptions of financial accounting?
Economic entity - a specific economic entity can be distinguished from other entities and from its owners
Going concern - the business is not expected to liquidate in near future
Unit-of-measure - the purchasing power of the currency is assumed to be constant
Periodicity - accounting info should be provided on a periodic, timely basis
What are the basic accounting principles?
Historical cost
Revenue recognition
Matching
Objectivity
Materiality
Consistency
Full disclosure
Conservatism
What is the most authoritative set of accounting pronouncements?
The FASB Codification
All announcements fall under the Codification ‘umbrella’
What is the highest authority within the FASB codification?
FASB SFAS (Statements of Financial Accounting Standards), APB (Accounting Principles Board) Opinions, ARBs (Accounting Research Bulletins)
What is the 2nd highest authority tier in the FASB codification?
FASB Technical Bulletins, Statements of Position (SOPs), Industry Guides
What is the lowest authority in the FASB codification?
Industry practices
Whose pronouncements are above industry practice in authority but below FASB Technical bulletins and industry guides within the FASB Codification?
Emerging Issues Task Force (EITF)
How does managerial accounting differ from financial accounting?
Managerial Accounting has a “timeliness” focus
Managerial Accounting does not 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 two primary constraints of Financial Reporting?
Cost vs. Benefit
Materiality
What are the secondary constraints of Financial Reporting?
Consistency - Year vs. Year
Comparability - Company vs. Company
What are the fundamental qualitative characteristics of useful financial reporting?
Relevance
Faithful representation
What are the enhancing qualitative characteristics of useful financial reporting?
Comparability
Verifiability
Timeliness
Understandability
Describe ‘Relevance’ as a Qualitative Characteristic
Makes a difference to the user
Includes:
Predictive Value - Future Trends
Confirming Value - Past Predictions
Materiality - Could affect User Decisions
What are the qualities of Faithful Representation?
Completeness - Nothing omitted that would impact the decision-making of a user
Neutrality - Information presented is without bias
Freedom from Error - No material errors or omissions
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
How should accounting policies be reported?
All significant policies should be disclosed, though no specific format is required
Separate note or “Summary of Significant Accounting Policies” before notes is preferred
Should include unusual application of acceptable principles
Should not duplicate details from elsewhere in financial statements
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 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 (exit price)
Assumes asset is at its highest and best value with sufficient exposure to market
Assumes asset is sold at its most advantageous market - principal market - to get the best price possible, and acquired for the highest and best use of the asset (only for nonfinancial assets)
Excludes adjustments for transaction costs
What is considered in determining the highest and best use of an asset for fair value purposes?
Whether it is
- physically possible
- legally permissible
- financially feasible
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 are the two kinds of inputs for valuation techniques?
Observable - reflect the assumptions which would be used based on data from sources independent of the reporting entity
Unobservable - the entity’s assumptions about the assumptions mentioned above
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?
Observable inputs besides quoted prices for the item
Interest rates, prime rate, quoted prices for similar assets (or even for identical items in nonactive markets)
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 is the fair value option?
Decision to measure eligible items at FV, though it is not required
Decision is irrevocable and must be applied to entire instrument
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?
Liabiities that will use current assets during the present operating cycle
What are valuation accounts?
Reductions or increases in an asset or liability account from its carrying amount
Part of the related asset or liability - neither an asset nor a liability in itself
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
What does it mean for an account to be price-level adjusted?
Adjusted for changes in the dollar’s purchasing power
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 profit is recognized until all costs are recovered from purchase of the asset
Most conservative method of revenue recognition when collection of sale price is uncertain
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, but before Extraordinary Items
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
Reported Net of Tax after Discontinued Operations
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
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 are some major risks and uncertainties that must be disclosed?
Nature of Operations
Use of Estimates & listing of Significant Estimates
Concentration vulnerability
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
What is capital maintenance?
Principle that income is recognized only after capital has been maintained
Amount of capital at end of period must equal or exceed beginning-of-period amount
Financial capital maintenance (used in present financial statements) measures capital as a cash amount
-Physical capital maintenance measures physical productive capacity
What is realization?
The process of converting non-cash resources and rights into money
“Realized” and “unrealized” refer to gains or losses on assets sold and unsold, respectively
How many levels of authoritative GAAP are there?
One – two levels total, one of which is authoritative (FASB Codification), the other of which is nonauthoritative (all other literature)
What else does the FASB Codification include guidance on?
SEC content
Is collecting cash on a receivable an instance of realization?
No
Realization involves conversion from noncash assets to cash OR CLAIMS TO CASH – so receivables are already deemed to be cash assets
How do financial statements provide information on management?
Indirectly – info on company’s economic activities directly
What is the role of the Statements of Financial Accounting Concepts (SFACs)?
To give concepts for the further development of GAAP
Does not itself establish GAAP
What assets are not permitted to be revalued at FV?
Financial instruments classified by the user as equity
When are deferred tax liabilities counted as current?
If they are expected to “reverse” within the year
“Reversal” for DTLs involves the company paying the liability
What is required for a new FASB Standard to be issued?
Majority vote of FASB board members
