BB4Entre Exam 5

The revenue recognition concept

The revenue recognition concept requires that you record the revenue from these first-day sales.--The dollar amount of each sale, the cash received, credit provided to customers and recorded as accounts receivable and the cost to Global Grocer of the goods sold (COGS) are shown in this table. In each of these sales, goods have been delivered to the customer and cash has either been collected or is expected be collected by Global Grocer. The revenues have been earned and are realized or realizable.

The indirect method statement of cash flows for an accounting period

The second format used to present the statement of cash flows is the indirect method. It is also organized by operating, financing, and investing activities. Here are two statements of cash flows for Global Grocer for September; the one on the left is a direct method statement of cash flows and the one on the right is an indirect method statement of cash flows for the same period. Both statements show that during the month, operating activities generated $4,600 in cash, investing activities used $10,000 in cash, and financing activities provided $49,900 in cash.

Global Grocer has purchased a warehouse building with an expected useful life of 10 years for $40,000. Which of the following is the best description of this new asset? A current asset A tangible asset A non-current asset A tangible, non-current asset

A tangible, non-current asset

Suppose Mansfield has a retained earnings balance of $20,000 on April 1, 2015. During the month of April, it earns a net income of $2,000 and also pays a dividend of $500 to its investors. What is its retained earnings balance at the end of April 2015?

$21,500-- Ending Retained Earnings = Beginning Retained Earnings + Net Income - Dividends = $20,000 + $2,000 - $500 = $21,500

On January 1, 2014, Scott Manufacturing has assets of $1,600,000 and liabilities of $900,000. Its owners' equity is _______.

$700,000--owners' equity = assets - liabilities = $1,600,000 - $900,000 = $700,000.

Five broad accounting concepts

- entity, money measurement, going concern, consistency and materiality

Report Prep

-financial reporting concepts and standards financial statements: 1. balance sheet 2. income statement 3. statement of cash flows requires aggregation of accounting transactions into statements or reports that describe the financial status of the business and its performance.

Liability

A liability represents an obligation(s) of the entity to other parties. To be recorded as a liability, an obligation must meet three requirements: 1-It involves a probable future sacrifice of economic resources by the entity 2-The economic resource transfer is to another entity 3-The future sacrifice is a present obligation, arising from a past transaction or event Ex: current and non-current liabilities -$15,000 owed to trade creditors -$50,000 short-term debt (owed to bank) -$25,000 mortgage payable (owed to bank) Not examples: -bill the owner of the store next to Global Grocer, helped sweep up leaves in front of both stores: it is understood that you will help in a similar way in the future -you, Global Grocer's owner, got a parking ticket for illegally parking the family car in front of the store

Accrual accounting

Accrual accounting attempts to record the financial effects on a business of transactions that have economic consequences for the business in the accounting period when the transaction occurs rather than only in the periods when cash is received or paid by the company. At this stage, some simple examples will help give meaning to the term accrual accounting as contrasted with cash-basis accounting. When applied consistently, accrual accounting is a means of enhancing the relevance of financial statements. Cash-basis accounting results in inadequate and misleading financial statements for all but the most simple of businesses. As a result, accrual accounting is the accounting system of choice throughout the world today.

Are assets tangible or intangible?

An item can be an asset whether or not it has physical substance, i.e., whether or not it can be touched and felt. Assets like computers and buildings having physical substance are tangible assets. Other assets, like licenses and prepaid expenses that lack physical substance, are intangible assets. ex of tangible asset: merchandise inventory ex of intangible asset: franchise fee

fundamental accounting equation

Assets = Liabilities + Owners' Equity

Choose the pair of words that best completes the fundamental accounting equation: _________________ = Liabilities + ________________

Assets....Owners' Equity

Which one of the following best describes a balance sheet? A)A description of the entity's operations over a period of time B)A snapshot at a point in time of an entity's assets, liabilities and owners' equity C)A reconciliation of an entity's bank account balance D)A two-column statement listing assets on the right side and liabilities and owners' equity on the left side

B)A snapshot at a point in time of an entity's assets, liabilities and owners' equity

Which one of the following best describes an asset that is expected to provide economic benefits for three years and does not have physical substance? A)A current tangible asset B)A non-current tangible asset C)A non-current intangible asset D)A current intangible asset

C)A non-current intangible asset

Suppose Barnum and Sons obtains a 5-year $100,000 bank loan, payable at maturity. Which one of the following describes the effect of this transaction on its balance sheet? Cash increases by $100,000; common stock increases by $100,000 Cash increases by $100,000; current liabilities increase by $100,000 Accounts receivable increases by $100,000; long-term debt increases by $100,000 Cash increases by $100,000; long-term debt increases by $100,000

Cash increases by $100,000; long-term debt increases by $100,000

Dividends

Dividends are distributions of earnings to owners, usually in the form of cash. The payment of a dividend reduces the Retained Earnings account.

Record the effect of the third and final sale of the week: 100 pounds of Colombian coffee are sold for $400. The customer paid $150 in cash and put $250 on a credit account with Global Grocer. Which one of the following choices correctly describes the effect on balance sheet of the revenue recognized from this sale? A)Cash + $400....Retained earnings + $400 B)Cash + $400....Accounts receivable - $250...Retained earnings + $150 C)Cash + $150....Accounts receivable - $150 D)Cash + $150....Accounts receivable + $250....Retained earnings + $400

D)Cash + $150....Accounts receivable + $250....Retained earnings + $400

Ledger: T accounts

Each T-account is associated with a single account, such as Cash, Accounts Payable, Common Stock or Sales. The T-account is literally a large 'T' with an account name on top. The left side of the T-account is the debit side. The right side of the T-account is the credit side. So, in financial accounting, debit means left side, and credit means right side. Before you proceed, you must memorize this fact. At any given time, each account has a balance (the monetary amount in that account). An account may have a debit (left-side) or a credit (right-side) balance.

financing activities

Ex: cash flows from financing activities relate to borrowing or retiring debt and to increasing or decreasing owners' equity in the firm. The impact of such activities on the cash account is recorded in the financing activities section of the statement of cash flows. At Global Grocer, cash from bank loans and amounts received from owners are reported in this section of the statement of cash flows.

A non-profit agency cannot be a financial accounting entity. True False

False-Any organization that needs to keep and communicate financial records can be an accounting entity. Whether or not it makes or aims to make a profit is irrelevant.

In the United States, the ------ sets accounting standards.

Financial Accounting Standards Board (FASB)--It has adopted a set of essential accounting concepts. They form the basis of a large number of accounting standards that provide guidance to accountants on how to account for specific types of transactions. These standards and the details on how to apply them, if printed in hard copy, would number in the thousands of pages.

Realization

Realization is the process of converting assets, such as merchandise for sale, into cash, cash equivalents, or good accounts receivable. Realization plays an important role in determining when revenue is recognized. Two conditions must be satisfied. First, the revenue must be earned, which typically means that the customer has received the good or service. Second, the revenue must have been realized or realizable, implying that the customer has paid or is expected to pay for the merchandise. --customer pays to have chair made(money realized) dont record sales payment on income statemnet until product/service is given to customer (then its recognized revenue)

On June 2, 2014, Mansfield purchases a computer system for $22,000 from Infostore Systems. Mansfield pays $10,000 in cash and promises to pay Infostore the rest in equal installments over the rest of the year. The computer system is expected to last four years. Which of the following would you do in this situation? Record a new asset, Computer System, for $10,000 Record a new asset, Computer System, for $22,000 Do not record the asset until it is fully paid for in a year's time Record a new asset, Computer System, for $12,000

Record a new asset, Computer System, for $22,000--Mansfield has just acquired a new asset, computer system for $22,000. This is what should be recorded on its books

double-entry bookkeeping

Recording both sides of each transaction is known as double-entry bookkeeping.

The IFRS and GAAP revenue recognition rules

The IFRS and GAAP revenue recognition rules differ in their wording and underlying theory. IFRS recognizes revenue when the "risks and rewards of ownership are transferred." In contrast, GAAP, among other requirements, recognizes revenue when it is "earned." Despite these differences, in most cases the accounting for revenue transactions will be the same under either concept.

link to balance sheet

The balance sheets at the beginning and end of an accounting period are linked, by the income statement for the period, through the retained earnings account in the owners' equity section of the balance sheets.

The dual-aspect concept

The dual-aspect concept formalizes the idea that there are two sides to every accounting transaction. Recording both sides of each transaction is known as double-entry bookkeeping. The dual-aspect concept has a very important implication: after both sides of each accounting transaction are recorded on the entity's books, the basic accounting equation should remain balanced

Which one of the following is not a requirement for an item to be an asset? The item must have been acquired at measurable cost. The item must be obtained or controlled by the entity. The item must be fully paid for by the entity. The item must be expected to produce future economic benefits.

The item must be fully paid for by the entity.

The retained earnings account

The retained earnings account is the sum of the company's net income to date, less dividends, if any, paid to the owners. The net income for the period is added to the retained earnings amount reported on the period's beginning balance sheet to determine the period's ending retained earnings, before any dividend payments.

financial ratio analysis

Users of financial statements use a technique known as financial ratio analysis to assess the financial position and performance of an entity. Financial ratios are ratios based on the amounts in the financial statements. Two simple balance-sheet-based ratios are introduced in this section. They are the current ratio and the long-term-debt-to-equity ratio.

Gross margin

We calculated gross margin by subtracting from sales the cost of goods sold ("COGS"). Next we subtract the entity's other expenses of running the business to determine net income. -also called gross profit b/c operating expenses not yet accounted for -the gross margin are displayed in three categories: operating expenses, interest expense and income tax expense.

income statement

a financial description of an entity's operating performance during an accounting period. It reports the entity's sales, expenses and net income or loss for the period. The income statement's basic equation is Sales minus Expenses equals Net Income. format: sales--are increases in assets or decreases in liabilities during a period result from delivering goods/services Less:__ --from sales we subtract the expenses associated with generating the sales of the period. Expenses are decreases in decreases in assets or increases in liabilities during a period resulting from the delivering of goods/service ex: Cost of goods sold, operating expenses, income tax expenses, interest expense (subtract to get gross margin, again for operating income/profit, and again for income before income taxes net income--total

operating activities

activiities that are related to the delivery of goods/services. the cash impact of such activities is recorded in the operating activities section of the statement of cash flows. At Global Grocer, this section of the statement of cash flows. At Global Grover, this section of the statement of cash flows would, for example, report cash collected from customers, cash paid to suppliers and cash paid to employees as parto f its daily business activities cash flows from operating activities

Balance Sheet

also called a statement of financial position, is a report of the organization's financial situation at a particular point in time. It lists the entity's assets, liabilities and owners' equity. It is called a balance sheet because it reports the balance or amount in each asset, liability and owners' equity account. Layout: is a snapshot at a specific point in time, of the resources controlled by an entity (assets), the claims against those resources (liabilities), and the owners' residual interest in the entity (owners' equity). In the side-by-side format shown, assets are listed on the left side of the balance sheet; liabilities and owners' equity are listed on the right.

Owner's Equity

also known as net assets (meaning net of liabilities).other names for it are stockholders' equity or shareholders' equity, or, just equity -Owners' equity is what remains after subtracting total liabilities from total assets. So, owners' equity = total assets - total liabilities ex: -common stock -retained earnings

A liability on the balance sheet represents _________________ of the entity.

an obligation--A liability is indeed an obligation on the part of the entity. It represents a future sacrifice of an economic resource by the entity, and obligation to transfer assets or provide services as a result of a past transaction or event.

sales

are increases in assets or decreases in liabilities during a period result from delivering goods/services

investing activities

are those that are related to the purchase and sale of long lived assets. The impact of such activities on the cash account is recorded in the investing activities section of the statement of cash flows would, for example, report the cash used to purchase a van Cash Flows From Investing activities

Users' Business Decisions

based on their analyses of financial statements, financial statement users take actions, which in turn, affect the future operating, investing, and financing decisions made by the organization. Hence, the financial reporting system is an info feedback loop b/w users of financial statements and the decision makers w/in the org

Sales

sometimes denoted as Sales Revenue(s), is the sum of the entity has earned during the accounting period in exchange for the goods/services it has provided to its customers. The economic benefits may be increases in assets or decreases in liabilities

On the balance sheet, assets are organized into two categories:

current and non-current--Current assets include cash and those assets that are expected to be converted into cash or consumed within 12 months of the balance sheet date. Non-current assets are assets that are expected to provide economic benefits for periods longer than a year.

examples of current and non current liabilities

current: 1. accounts payable 2. taxes payable 3. short term debt non current: 1. mortgage payable

Income Statement

details the entity's operating performance during a specific period of time, known as the accounting period, displayed at the top of the statement. The income statement lists the revenues earned and expenses incurred during the period; subtracting expenses from revenues results in the measurement of net income for the period. Chapter 4 covers the income statement in greater detail.

The statement of cash flows

details the sources and uses of cash by the entity over an accounting period. For the convenience of financial statement users, the statement of cash flows is organized by type of business activity: operating, investing and financing.

five basic financial accounting concepts:

entity, money measurement, going concern, consistency and materiality

The dual-aspect concept tells us that

every accounting transaction has two sides which must be recorded.

Financial Reporting Concepts and Standards

financial reporting concepts and principles tell us when and how to measure, record and classify bus transactions and aggregate them into financial reports. By following these concepts and principles, financial reporting systems provide info that is consistent over time and across diff bus's, and accounting becomes a language that is widely understood.

Accrual accounting

focuses on capturing the economic meaning of a transaction, rather than its cash effects. This usually results in a difference between a period's net income and the operating cash flow to the entity, although both are the result of operations during the period. For example, in August, Global Grocer had a zero net income, but it had a negative operating cash flow of $11,000.

Sun Electronics purchases a stamping machine for $10,000. Almost immediately, a trade embargo restricts the number of stamping machines that can be imported into the U.S. Based on want ads in the commercial section of the newspaper, stamping machines like Sun's are now selling for $15,000. Sun Electronics should immediately

follow the historical cost concept and leave the stamping machine at its $10,000 cost on the books.

The money measurement concept

states that financial accounting deals only with things that can be represented in monetary terms. This concept is so intuitive that it is usually taken for granted. But, since it is so important, it is stated as a basic accounting concept.

The direct method statement of cash flows for an accounting period

summarizes the transactions that have been posted to the cash ledger account during the period. This information is presented in three categories: operating, investing and financing activities. Here you see Global Grocer's direct method statement of cash flows for the month ending August 31, 2014. The indirect method statement of cash flows will be discussed later in this chapter.

expenses

the assets used or liabilities incurred by the entity during an accounting period to provide the goods and services that generated revenue during the period. ex: 1. less: costs of goods sold 2. less: operating expenses 3. Less: interest expense 4. less: tax expense

Recording System

-financial reporting concepts and standards transactions are formally recorded in a database called a journal, and then organized by accounts into a ledger Tracking and recording transactions: 1. journal 2. ledger 3. closing and adjusting entries 4. T accounts

two important qualities of financial accounting information

-relevance and reliability

Users of Entity's Financial Statement

-users' bus decisions 1. managers 2. investors 3. analysts 4. lenders 5. customers 6. suppliers 7. unions/employees 8. regulators Finanacial statements are used by decision makers inside/outside the bus. For ex: managers use them to decide whether the firm is making a profit, whether customer incentives are working, or whether to take a loan and expand the bus. If a bus raises capital from outside investors, the investors will examine the company's financial statements to judge whether the funds they have invested have been used wisely

Company transactions

-users' bus decisions Ex: managers will raise capital from investors and banks, rent or buy equipment, and purchase transaction is related to one of three of activities: 1. operating 2. investing 3. financing activities

4 Criteria for being an asset and 3 examples

1. acquired at measurable cost? 2. obtained or controlled? 3. expected future economic benefits? 4. past transaction or event? ex: a) $50,000 cash raised from short-term bank loan b) warehouse property purchased for $70,000 cash; Global Grover acquires deed to the warehouse and lang c) merchandise purchased for $18,000; paid $8,000 in cash, the remainder on a credit NOT ex's: a) Global Grocer international's reputation for quality, selection and service to customers b) employee signs a contract to work for $2,000/month c) merchandise purchased for $5,000 by Global Grocer, now past its sell-by date

Farrah Company's December 31, 2014, balance sheet shows current assets of $250,000 and current liabilities of $100,000. Its current ratio is _______. 250 2.5 0.4 none

2.5--the current ratio which is calculated as current assets divided by current liabilities aka 250,000/100,000=2.5

The current ratio

An entity's ability to meet its current obligations - those due within the coming year - is an important measure of its financial health. These short-term obligations are usually repaid in the normal course of business, as the entity's current assets are converted to cash. For example, cash is generated when merchandise inventory is sold for cash, or when accounts receivables are collected in cash from customers. This cash can then be used to pay accounts payable. The current ratio, or ratio of current assets to current liabilities, is a measure of an entity's ability to meet its maturing short-term obligations. In the current ratio, the numerator, current assets, represents the resources of the entity that are either cash or expected to soon be converted into cash. Cash and these asset conversions to cash can be used to satisfy the immediate claims of short-term creditors. The denominator, current liabilities, represents the current claims of creditors that must be extinguished in the near-term. While there is no single ideal current ratio, financial statement users often employ the rule-of-thumb that a healthy business will have a minimum current ratio of 2. Because the appropriate current ratio varies by industries, financial statement users tend to focus on an entity's current ratio relative to those of other, similar businesses. In the U.S., the pharmaceutical industry has had an average current ratio of 1.8 over the past decade; the software industry, on the other hand, has had a 2.9 average current ratio over the same time period. Software companies, with their limited need for fixed assets, traditionally hold a much larger proportion of their assets in cash and monetary current assets, and this is reflected in their significantly higher current ratios. If financial statement users notice that an entity has a current ratio that is significantly higher than that of its peers, they may be concerned that the entity holds more cash or inventory than a business needs. This may signal that it is locking up potentially productive capital. If, on the other hand, an entity has current ratio that is significantly lower than that of its peers, financial statement users may question its ability to satisfy its current obligations in a timely manner.

Given the relative complexity of the operating section of an indirect method statement of cash flows, you might wonder why do accountants use them at all?

Answer: Because the operating section of the indirect method statement explains the difference between the net income and the operating cash flows of the period, it provides readers with information about the extent to which and the means by which the entity's net income of the period has resulted in operating cash flows.

Going concern concept

Going concern is accounting's way of saying that an entity is expected to remain in operation for the indefinite future. The going concern concept directs the accountant to explicitly make this assumption in the absence of evidence to the contrary. The significance of the going concern concept can be understood by considering the alternative: that the entity is about to go out of business. If this was the case, all its resources should be valued at their current worth to potential buyers. The going concern concept directs the accountant, under the normal course of business, to ignore this doomsday scenario. ex: merchandise inventory

Principles Based versus Rules Based

IFRS tends to be stated as in the form of broad principles. In contrast, much of GAAP tends to be stated in the form of bright-line rules. For example, as you will learn later along with various accounting rules, under GAAP if a term of a lease is equal to 75 percent of the economic life of the leased property, the lease will be accounted for as a capital lease. On the other hand, if the lease item is equal to 74 percent or less of the leased property's economic life, the lease will be accounted for as an operating lease. IFRS takes a different approach. It makes the distinction between a capital and an operating lease based on which party - the lessor or the lessee - substantially bears the risk and reward of ownership. The distinction between the principle based and rule based accounting standards is important. Under a principle standards model, the accounting for transactions is more likely to reflect the substance of the transaction. Under a rule based standards model, the accounting for a transaction is more likely to reflect the form of the transaction. As GAAP and IFRS converge, it is anticipated that GAAP will become more principle based.

Accrual vs Deaccrual

Recall that accrual accounting records the economic effects of transactions in the period in which those transactions occur, rather than in the periods in which cash is received or paid by the entity. Under accrual accounting, we record some accruals that have related cash flows in the future, and the resultant balance sheets and income statements reflect the effects of those accruals rather than use future cash flows. Used in indirect method statement cash flows Net income (accrual) add/subtract (deaccrual) deaccrual is an adjustment made to net income to arrive at the cash effect of operating activities. we will analyze examples of each type of de-accrual in turn.

To users of an entity's financial statements, which of the following is a potential limitation of the historical cost concept?

Recorded asset values may not be current, hence may not be relevant in judging the entity's financial condition.

The Realization Concept

The Realization Concept and its associated "earned" requirements provide guidance as to when to recognize revenues and the Matching Concept provides guidance as to when to recognize expenses. The Conservatism Concept goes one step further by recommending that prudence be exercised in recording revenues and expenses. It says that revenues should be recognized only when reasonably certain, but expenses should be recognized as soon as reasonably possible. Conservatism in financial accounting means that an entity should recognize only those revenues for which there is a high degree of confidence that they will be earned and realized. Expenses, on the other hand, should be recorded as soon as they seem likely to be incurred. If the entity is uncertain whether to recognize an expense or about the amount of an expense, the conservatism concept encourages it to pro-actively estimate the cost and record the expense. The conservatism concept also applies to the balance sheet. It suggests prudence in the recording of assets (record when reasonably certain) and in the recording of liabilities (record as soon as reasonably possible). Further, if two different estimates of a balance sheet amount were equally acceptable, the conservatism concept would guide accountant to record the smaller amount when measuring assets and the larger amount for liabilities. Care must be taken when applying the conservatism concept. Otherwise, it can lead to bias in financial statements by understating profits in one period only to be followed by overstatement in a subsequent period.

The total debt to equity ratio

The composition of a company's long-term capital structure - primarily its total interest-bearing debt and owners' equity - is of interest to financial statement users seeking to assess the long-term financial viability of an entity. Of particular interest is the ratio of total debt (capital that accrues interest and has to be repaid to lenders) to equity capital (capital that does not demand interest and does not have to be repaid). The total debt to equity ratio is useful for judging an entity's long-term financial viability. As the name suggests, it is the ratio of all interest bearing debt on the balance sheet to total equity. This ratio measures financial leverage or the degree of the entity's indebtedness relative to its equity funding. Debt and equity are very different kinds of capital. When an entity assumes debt, i.e., accepts a loan, it has to pay interest and also repay the loan to the debt holder over an agreed-upon period of time. If the entity runs into hard times and fails to pay its maturing financial obligations to its debt holders, they can force the entity into bankruptcy. Equity capital, on the other hand, is a residual claim on the entity's assets. If a company becomes insolvent, equity holders get what remains after debt-holders have been satisfied. So, the larger the size of an entity's debt obligations relative to equity, i.e., the larger its total debt to equity ratio, the greater is the implied strain on the entity to make regular payments to debt holders, and the higher is the risk of bankruptcy.

The consistency concept

The consistency concept states that an entity should use the same accounting methods and procedures from period to period unless it has a sound reason to change methods. The consistency concept needs to be explicitly stated because some accounting standards allow a fair degree of variation in how transactions are recorded. The consistency concept reduces the likelihood of opportunistic or whimsical changes in accounting procedures by an entity. Note that the consistency concept does not forbid a switch in accounting procedures. If an entity does make a procedural accounting change, its management and auditors are required to note the change in their discussion of the entity's accounts. Note also that in the context of accounting concepts, consistency means consistency over time.

Income statement: Balance sheet effect

The effect on the balance sheet of this profitable sale of 100 pounds of Colombian coffee for cash and credit is shown here. The cash account increased by $150, accounts receivable increased by $250, merchandise inventory declined by $260 and retained earnings increased by $140. The fundamental accounting equation remains in balance. aka 250+150-260=$140=retained earnings

The entity concept

The entity concept is the most basic accounting concept. It states that accounts are kept for an entity as distinct from the people who own, run or do business with the entity. The entity concept is simple but powerful. It allows the accountant to draw a virtual boundary around the entity and hence limit the activities that need to be tracked and recorded.

Historical Cost: Relevance/Reliability

The historical cost concept provides a degree of reliability in the entity's accounts. It allows the accountant to ignore opinion and hearsay about the monetary value of items, and to report amounts based on actual transactions. But, the use of the historical cost concept also means that some amounts on an entity's balance sheet are based on historical values, determined at the time of purchase, which could predate the current balance sheet date by years. Consequently, it is unlikely that the asset amounts on the balance sheet reflect the value that the assets would fetch if they were sold today. In this sense, the financial statements may be 'less relevant' for the purposes of users of the entity's balance sheets, than if current market prices were reported. As noted earlier, when relevance and reliability have to be traded off, financial reporting practice tends to favor reliability. Hence reliance on the historical cost concept may sometimes yield more reliable but less relevant financial information. However, accountants are not blind to the relevance issue. As you will learn in more advanced accounting classes, many monetary assets are recorded initially at their cost, and subsequently measured and reported in the balance sheet at their market value. Monetary assets are items such as marketable securities. Their market value can generally be estimated reasonably reliably. In addition, you will learn how accountants enhance relevance by recording some transactions to reflect their substance rather than their form. While IFRS favors the historical cost model, it does present as an acceptable alternative treatment the revaluation of land and buildings to their market value, if their value can be measured reliably subsequent to their initial recognition at cost.

The historical cost concept

The historical cost concept, also known as the cost concept, provides guidance as to the amount at which a transaction should be reported initially in the entity's accounts. It requires that transactions be recorded in terms of their actual price or cost at the time the transaction occurred. Global Grocer is planning to buy a warehouse property. The historical cost concept directs you to record the warehouse property at its acquisition cost of $70,000. Others may think the warehouse property is worth more or less than the amount Global Grocer paid, but their views are irrelevant. The accounting records will record the warehouse transaction initially at the amount actually paid for it. (reliability)

The materiality concept

The materiality concept states that an entity need only apply proper accounting to items that are material, i.e., significant to potential users of the financial statements. This concept allows the accountant to be practical in choosing the appropriate degree of precision in the accounts Just what is material and not material is not made specific in accounting. The general rule is that, "An item is material if its disclosure would impact the decisions of the users of the accounts." The application of this rule requires accountants to judge what users of financial statements would consider significant to their decisions. As in most matters requiring judgments, reasonable people can differ. Determining materiality is no exception. ex: paper clip vs van

IFRS recognizes revenue when all the following conditions have been satisfied:

The seller has transferred to the buyer the significant risks and rewards of ownership of the goods; The seller retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the good sold; The amount of revenue can be measured reliably; It is probable that the economic benefits associated with the transaction will flow to the seller; and The costs incurred or to be incurred in respect of the transaction can be measured reliably.

Differences between direct and indirect method statement of cash flows

The two statements differ in only one area: the format and information included in the cash flows from operating activities section. The investing and financing cash flows sections are exactly the same in both types of statements of cash flows. SS--indirect has operating activities in subsections "net income" (accural) separated into "Add:" and "Subtract:" (the deaccruals)

Is there an ideal total debt to equity ratio?

There is no single ideal total debt to equity ratio. Over the past couple of decades, in the U.S., the average total debt to equity ratio for public companies has ranged from 0.5 to 1.0. However, it can vary considerably from one industry to another. Businesses in stable industries with tangible assets that make good collateral tend to borrow heavily to finance those investments, so they tend to have high total debt to equity ratios. In contrast, volatile businesses with few tangible assets tend to have low total debt to equity ratios. In the U.S., the software industry, which traditionally holds very little debt, has had a 0.10 average total debt to equity ratio over the past decade. On the other hand, financial firms, which traditionally are very highly leveraged, have had a total debt to equity ratio of 3.3 over the same time period. If a company has a total debt to equity ratio that is significantly higher than that of its peers, financial statement users may be concerned about its ability to make the required payments to its debt holders and the company's long-term solvency may be questioned. If, on the other hand, a company has a total debt to equity ratio that is significantly lower than that of its peers, financial statement users may question whether the company is being aggressive enough in pursuing profitable growth opportunities by raising debt when necessary to finance those opportunities. As with other financial ratios, there is no single perfect total debt to equity ratio for any business. What is important is a company's total debt to equity ratio relative to those of other, similar businesses, and also how the ratio changes over time.

Generally Accepted Accounting Principles (GAAP)

are guidelines that accountants, managers and auditors must follow while preparing and auditing accounting information for external reporting purposes. For example, GAAP requires the use of accrual accounting. The application of GAAP rules results in reasonably reliable financial information, while also permitting each entity to reasonably describe its own business strategy and performance through relevant accounting information. In this tutorial, you will use GAAP to record Global Grocer's business transactions. However, you will not need to actually look up or refer to the Generally Accepted Accounting Principles each time. Instead, this tutorial will simply show you how to record Global Grocer's transactions according to GAAP. The Financial Accounting Standards Board (FASB) determines GAAP in the United States. There also exists an International Accounting Standards Board (IASB), which, among other activities, has undertaken a major effort to harmonize accounting standards around the world.

Sales and expenses are...

income statement accounts. However, they also affect the balance sheet, in particular, the retained earnings account. In order to build on our understanding of the fundamental accounting equation (Assets = Liabilities + Owners' Equity), we will illustrate the impact of these first-day sales on Global Grocer's balance sheet, and also begin to construct its income statement for September 2014. At the end of the accounting period, the month of September, we will complete Global Grocer's income statement.

Auditors

independent parties who periodically examine a company's financial statements and the systems, internal controls and records used to produce the statements. Since a company's managers produce their own report cards ie the company's financial statements, auditors play an important role as a control mechanism. They attest that the financial statements conform to generally accepted accounting principles and they provide assurance that the company's accounts are presented fairly

The International Accounting Standards Board (IASB)

publishes International Financial Reporting Standards (IFRS). Users of this tutorial can assume, unless noted otherwise, that the accounting for a particular transaction described in the tutorial is essentially the same under both GAAP and IFRS.

matching concept (income statement)

indicates what expenses should be recognized when revenue is recorded. The timing of expense recognition is important since revenue less expenses equals net income. The Matching concept stipulates that expenses should be recognized in the same period as the relevant revenues are recognized. Costs related to this period's activities but which are not directly related to products and services sold, are expensed this period.

Financial accounting reports are used by

investors, regulators, employees, customers and a number of other external parties. --So that this diverse list of users can understand an entity's financial statements, accountants must follow certain guidelines or standards when preparing financial accounting reports. These principles, more numerous than the accounting concepts, are explicit rules that are used to improve the reliability and comparability of financial reports.

Financial accounting

is a financial information system that tracks and records an organization's business transactions and aggregates them into reports for decision makers both inside and outside the business.

A transaction

is an event that has consequences for a business' financial condition. The event could be either external or internal to the business.

The Balance Sheet is so named because

it presents the balances of the various asset, liability, and owner's equity accounts.

cash flows

one of the three basic financial statements prepared and presented by an entity. It provides information about the entity's sources and uses of cash during an accounting period. The statement of cash flows can be presented in two different formats called the direct method and the indirect method. You will learn how to construct and use each type of statement of cash flows for Global Grocer.

Net income

or profit or net profit, is the difference b/w the sales and expenses of the accounting period. B/c it appears as the last line of the income statement, it is often referred to as the bottom line

Reliability

refers to the objectivity and verifiability of the information. Different ways of recognizing, measuring and recording an event may yield more or less reliable or more or less relevant account balances. Often, judgment has to be used to make the trade-off between relevance and reliability, i.e., there isn't a way to record a transaction that will maximize both these desirable properties. In such cases, reliability is generally given precedence over relevance.

Relevance

refers to the timeliness and usefulness of the information to its users. Often, judgment has to be used to make the trade-off between relevance and reliability, i.e., there isn't a way to record a transaction that will maximize both these desirable properties. In such cases, reliability is generally given precedence over relevance.

Choose the pair of words that best completes the following sentence: Since financial accounting reports are used to make decisions that affect the entity, financial accounting strives to present information about the entity that is __________ and _________. reliable....precise relevant....unchanging relevant....reliable precise....unchanging

relevant....reliable-- Financial accounting tries to present relevant and reliable data.

Which one of the following choices best completes this sentence: The total debt to equity ratio is useful for judging ___________________. the entity's ability to meet obligations that are due in the coming year the entity's long-term financial viability how efficiently the entity has used its bank loans the market value of its equity

the entity's long-term financial viability--The larger the amount of debt on its books, relative to equity, the greater the strain on the entity to service the debt and the greater the risk of being forced into bankruptcy if debt payment conditions are not met. The total debt to equity ratio is used to judge this risk.

The indirect method statement of cash flows does not require any new accounts. In practice, the indirect method statement of cash flows for an accounting period is constructed using

the period's net income, the period's depreciation and amortization expenses, differences between the period's beginning and ending current asset and liabilities accounts, excluding cash and short-term debt.

In financial accounting, the quality of the output depends on

the relevance and reliability of the data presented.

Financial accounting is an information system that

tracks and records an organization's business transactions.