ACG 3101 Exam 1

Finaancial ACcounting

Financial information is conveyed through financial statements and related disclosure notes: -Balance sheets -Income statement -Statement of cash flows -Statement of shareholders/stakeholders company

Committee on Accounting Precedure (CAP)(1938-1959)(Early US Standard Setting)

First private sector standard-setting body Comitee of the American Institute of Accountants (AIA) AIA: National professional organization for certified professional public acocuntnats AIA renamed as American Institute of Certifed Public Accountants (AICPA) Issued 51 Accounting Research Bullentians (ARBs) Accounting Principles Board (APB)(1959-1973)(Early US Standard Setting) Issued 31 Accounting Principles Board Opinions (APBOs), various interpretations, and 4 statements. Replaced by Financial Accounting Standards Board (FASB)

Accounting Equation for a Corporation

A= L + SE

T-Accounts

Account title at the top Debits on left, credits on right

EX 1. High Quality Financial Reporting Which of the following is NOT one of the ways in which high-wuality accounting is encouraged by the US financial reporting system?

Accounting standards encourage comparability Auditors asses whether financial statments are materially misstated. Sarbanes- Oxley instituted reforms designed to improve teh quality of financial reporting Managers are required to use frameworks for ethical decision making when deciding how to account for transactopns Answer is d, ethical frameworks can be very useful, but managers are not required to use them.

1933 Securities ACt:

Applies to initial offerings(ipo) of securities (stocks and bonds)

1934 Securities Exchange Act

Applies to secondary market transactions Mandates reporting requirements for companies whose securities are publicly traded.

Cash Vs. Accrual Accounting

Cash Basis Accounting: Measurement of cash receipts and cash payments from transactions related to providing goods and services. Difference is net operating cash flow Cash in revenue, cash out expenses Accrual Basis: Measurement of revenues and expenses, regardless of when cash is received or paid Difference is net income or net loss Has nothing to do with cash Record revenue when earned, record expenses when they occur Must be in same period they actually occur

EX 1. Cash vs. Accrual Carter company paid $60,000 for 3 years rent at the beginning of year 1

Cash basis: 60,000 is recorded in year one Accrual: split into 3 years at $20,000 each year, and recorded as an expense despite it being paid in year 1. Bottomline does not change

Accounting Standard Setting: Hieracy of Standard- Setting Authority

Congress> SEC> Private Sector (Cap, APB,FASB)

Hierarchy of Qualitative Characteristics of Financial Information

Cost effectiveness (Benefits exceeds costs) Materiality: Percentage of a dollar amount Completeness: Complete set of financial records (income statements, balance sheets, etc) Timeliness: Getting statements together quarterly, monthly, etc. Understandability: Being able to have many people understand your statements

Current Cost

Cost that would be incurred to purchase or reproduce the asset. Reported if the company operates in inflationary economies.

Securities and Exchange Commission (SEC)

Created by Congress in response to the stock market crash of 1929. Goal was to restore investor confidence

Efforts To Converge US & International Standards (IFRS)

FASB and IASB have been working for many years to converge to one global set of accounting standards, however, recent events suggest that full convergence will not be achieved in the foreseeable future.

Financial ACcounting Standards Board (FASB)

FASB created in 1973 Established to set U.S accounting standards Supported by Financial ACcounting Foundation (FAF) 7 full-time members

Important roles of accounting:

-produce good decisions -fosters a prosperous society

Measurement

GAAP currently employs a 'mixed attribute' meausremnet model: The five attributes are: Historical Cost: Original trasnaction value adjusted for depreciation and amortization Net Realizable Value: The amount of cash which an asset is expected to be converted in the ordinary course of busines (cash). Current CostL The cost that would be incurred to purchase or reproduce the asset Present Value: The current value of future cash flows, calculated by applying the time value of money. Fair Value: The price would be received to sell all assets or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

The Development of Financial Accounting and Reporting STandards Generally Accepted Accounting Principles:

GAPP is a dynamic set of both broad and specific guidelines that companies should follow when measuring and reporting the information in their financial statements and related notes. GAAP facilitates decision making by investors and creditors by allowing them to compare financial information among companies.

Emerging Issue Task Force (EITF) created in 1984

Identifies financial reporting issues and attempts to resolve them w/out involving the FASB. Primarily addresses implementation issues Speeding up the standard setting process EITF rulings are ratified by the FASB and are considered part of GAAP.

Accounting Equation- Services Performed in Account

Services were performed on account for $10,000. Asset = Liabilities + Equity (+10,000 Accounts Receivable) (+10,000 Revenue)

Accounting Equation- Supplies Used

$500 of supplies were used Asset = Liabilities + Equity (-500 Supplies) (-500 Expenses)

Accounting Equation- Borrowing Money From the Bank

$40,000 was borrowed from a bank and a note payable was signed. Asset = Liabilities + Equity (+40,000 Cash) (+40,000 Notes Payable)

Government Accounting Standards Board (GASB)

Developed accounting standards for governmental units such as states and cities.

A Move Away From Rule-Based Standards (GAAP)?

A principles based (IFRS), or objectives- oriented approach to standard setting stresses professional judgement, as opposed to following a list of rules or bright lines. Regardless, poor ethical values on the part of management are at the heart of accounting abuses and scandals.

Accounting Equation- Owner Investment

An attorney invested $50,000 to open up a law office. Asset = Liabilities + Equity (+ 50,000 cash) (+50,000 investment)

Four approaches:

Based on an exact cause and effect relationship By associating an expense w/ the revenues recognized ina specific time period By a systematic and rational allocation to specific time periods In the period incurred, w/out regard to related revenue.

EX.1 Accounting Standard Setting Accounting Standards in the US are currently set by?

FASB, since 1973

Present Value

Indicates that the objective in valuing an asset or liability using present value is to approximate its fair value.

Key variables in investment decision

Rate of return Uncertainty of risk

General Ledger Accounts

Serve as control accounts Subsidiary accountsL Maintained in a separate subsidiary accounts. Ex. Individual receivable accounts for each of the company's credit customers. Permanent Accounts: Represent the basic financial position elements (Assets liabilities, shareholders equity)(On balance Sheets) Temporary Accounts: Represents changes in the retained earnings component of shareholders equity caused by revenue, expense, gain, loss, and dividend transactions. Balances are closed or zeroed out. (On income statements)

Elements of Financial Statements

Assets (Balance Sheets) Liabilities (Balance Sheet) Equity (or net assets) (Balance Sheet Investments by owners (Stockholders Equity/ Balance Sheet) Distributions to owners Comprehensive income (Income Statement) Revenues (Income Statement) Expenses (Income Statement) Gains (Income Statement) Losses (Income Statement)

The Economic Environment & Financial Reporting

Capital Markets: Provides a mechanism to help the economy allocate resources efficiently.

Codification

FASB Accounting Standards Codification: Only source of authoritative non governmental U.S GAAP Organizes the thousands of U.S GAAP pronouncements into roughly 90 accounting topics Also included portions of SEC accounting guidance Accounting Standards Update (ASU): Any new standard issued by FASB Located at the FASB website

Rate of Return

Dividends + Share Price Appreciation (End Share Price -Begin. SHare Price) / Initial Investment= Rate of Return (%) Investors require a high expected rate of return. EX. 1 Rate of Return Assume an investor provides a company w/ $10,000 cash by purchasing stock at the end of 2020, receives $400 in dividends from the company during 2021, and sells the ownership interest (shares) at the send of 2021 for 10,600. $400 + $600 / 10,000 = 10%

Underlying Assumptions 4 basic assumptions underlie GAAP:

Economic Entity: Assumption presumes that economic events can be identified specifically with an economic entity. Going Concern: Assumption anticipates that a business entity will continue to operate indefinitely. Periodicity: Assumptions allow the life of a company to be divided into artificial time pearson to provide timely information.(Accrual basis of accounting) Monetary Unit: Used in U.S financial statements is the U.S dollar.

Net Realizable Value

Estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. Amount of cash into which an asset or liability is expected to be converted in the ordinary course of business.

Ethics and Professionalism

Ethiscs: Deals with the ability to distinguish right from wrong. Codes of Ethics or Codes of Professional Conduct are provided by: American Institute of Certified Public Accountants (AIPCA) Institute of Management Accountants (IMA) Institute of Internal Auditors (IIA)

Example of Uncertainty Consider the following 2 investment options. Which would you pick? Investing $10,000 in a savings account insured by the U.S government that will generate a 5% rate of return? *Safest*

Investing $10,000 in a profit-oriented company. *More riskier, but has higher rate of return* Risk/ Return Tradeoff: Most inventors would invest in the profit-oriented company vs. not for profit company only if the potential return is high enough.

Corporations acquire capital from:

Investors in exchange for ownership interest (stock) Creditors by borrowing (either through individual loans or publicly traded debt such as bonds)

Politics in Standard Setting

Mid 1990's: Accounting for employee stock options Implementation of the fair value accounting standard issued in 2007.

Expense Recognition

Often matches revenues and expenses that arise from the same transactions or other events

Historical Cost

Original transaction value. Bases measurements on the amount given or received in the exchange transactions. For assets: Value of what is given in exchange(usually cash) for the asset at its initial acquisition. For liabilities: Current, cash equivalent received in exchange for assuming the liability. Long-lived, revenue producing assets (equipment): Adjusted subsequent to its initial measurement by recognizing depreciation or amortization.

Fair Value

Originally called ' Current Market Value

Key Provisions of teh Sarbanes Oxley Act

Oversight board Corporate executive accountability Nonaudit services Retention of work papers Auditor rotation Conflicts of interest Hiring of auditor

Stockholder Equity

Paid in Capital (Common STock) (Debit:- / Credit: + Retained Earnings: Debit: - / Credit: + Gains: Debit: - / Credit: + Losses: Debit: + / Credit: - Expenses: Debit: + / Credit: - Dividends: Debit: + / Credit: - Revenues: Debit: - / Credit: + Account Relationships Double entry system: Dual effect that ecah transaction has on an accounting ewaution Accounts: Represents the elements of the accounting equation General Ledger: Collection of Accounts T-Account: Used for instructional purposes instead of formal ledger accounts

Primary Objectives of Finacial Accounting

Provided information should be useful for decision amking. Information should help investors and creditors evaluate the following characteristics of the enterprises's future cash receipts and disbursements: AMount Timing Uncertainty

Providers vs Users of Financial Info

Providers: Profit-oriented companies, not-for-profit entities, households Users: Investors, creditors, labor unions, suppliers, stockbrokers etc.

The Conceptual Framework aka Accounting Constitution

Provides an underlying foundation for U.S accounting standards Guides the selection of events to be accounted for Measurement of those events Means of summarizing them and communicating them to interested parties. Provides structure and direction to financial accounting and reporting Disseminated by FASB through Statments of Finacial ACcounting Concepts (SFACs)

Primary Focus of Financial Accounting

Provides financial information to various external users. Used to predict future risk and potential return of investments or loans before supplying capital to businesses. -Investors -Creditors -Other external users

Recognition, Measurement, and Disclosure Concepts

Recognition: Refers to the process of admitting info into the financial statements Measurement: Process of associating numerical amounts w/ the elements Disclosure: Process of including additional pertinent information in the financial statements General Recognition Criteria: Definition, Measurability, Relevance, and Reliability

Financial Reporting

Refers to the process of providing financial information to external users.

Fair Value Hierarchy

Reflects the subjectivity of inputs used to compute fair values. 1(Most Desirable): Quoted market prices in active markets for identical assets or liabilities. 2(Average): Inputs other than quoted prices that are observable for the asset or liability. These inputs include quoted prices for similar assts/ liabilities in active/ inactive markets and inputs that are derived principally from observable market data. 3(Least Desirable): Unobservable inputs that reflect the entity's own assumptions about the assumptions market participants would use in pricing the asset/ liability developed based on the best information available in circumstances.

Revenue Recognition

Revenue: Inflows or settlements of liabilities resulting from providing a product or service to a customer. Revenue recognition used to be guided by the realization principle (two criteria) Earnings process is judged to be complete or virtually complete Reasonable certainty as to the collectability of the asset to be received (usually cash). FASB issued ASU NO. 2014-09, which requires that we recognize when goods or services are transferred to customers for the amount the company expects to be entitled to in exchange for the goods or services.

Encouraging High-Quality Financial Reporting

Role of an Auditor: Offer credibility of financial statements Express an opinion (can't say whether something is right or wrong) on the compliance of financial statements with GAAP Licensed by states to provide audit services- certified public accountants. Financial Reporting Reform Accounting Scandals increased the pressure on lawmakers to pass mesures that would restore credibility and investor confidence in the financial reporting process. EX. Sarbanes- Oxley

Accounting Equation- Salaries paid to Employees

Salaries of $5,000 were paid to employees. Asset = Liabilities + Equity (-5,000 Cash) (-5,000 Expenses)

EX 2. Cash vs. Accrual Which of the following are NOT an advantage of accrual accounting?

Spreads the influence on one-time events that affect multiple reporting periods. Highlights cash effects of operation Captures long-run performance Recognizes assets and liabilities associates w/ receivables and payables. Answer is 2.

Accounting Equation- Supplies Purchased on Account

Supplies costing $3,000 were purchased on account. Asset = Liabilities + Equity (+3,000 Supplies) (+3,000 Accounts Payable)

Steps of the Accounting Processing Cycle

The Accounting Cycle Process: Steps 1& 2 {During the accounting cycle} Identify external transactions affecting the accounting equation. Obtain information about transactions from source documents Ex. sales invoices, bills from suppliers, cash register tapes. Identify the date and nature of each transaction, the participating parties, and the monetary terms. Analyze transactions Transaction analysis: The process of reviewing the source documents to determine the dual effect on the accounting equation and the specific elements involved. Step 3: Record the Transaction in a Journal Journals: -Provide a chronlogigical record of all economic events affecting a firm - Each entry is expressed in terms of equal debits and credits - Special Journal: Records a repetitive type of transaction. Ex. sales journal - General Journal: ANy transaction not recorded in a special journal.

The Accounting Equation

Underlies the proces sussed to capture the effect of economic events: Assets= Liabilities + Equity (Total Claims)

Perpetual Inventory System

When inventory and cost of goods sold accounts are continuously updated for purchase, sale, and return of merchandise.

The Investment- Credit Deccision: A Cash Flows Perspective

Why do investors and creditors provide capital? They want to earn a fair return on the resources they provide Shareholders receive cash from: Sales of the ownership shares of stock Periodic dividends