Chapter 1 - Intermediate Accounting

Example calculation of rate of return: Assume an investor provides a company with $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 end of 2021 for $10,600.

$400 dividends + $600 share in price appreciation / $10,000 initial investment = 10%

Practice Problem: Creecher purchased $200,000 worth of Troman stock , received four quarterly dividends of $1,000 each, and sold the Troman shares for $206,000 after one year. What is Creecher's rate of return?

(4 x $1,000) dividends + $6,000 share in price appreciation / $200,000 investment = 5%

Expense recognition is implemented by which of the following ways?

1. Associating expenses and revenues in a specific period of time. 2. Cause-and-effect relationship. 3. Systematic and rational allocation. 4. In the period incurred.

General Recognition Criteria

1. Definition 2. Measurability 3. Relevance 4. Reliability

Measurement five attributes

1. Historical Cost 2. Net realizable value. 3. Current Cost 4. Present Value 5. Fair Value

Four basic assumptions underlie GAAP

1. The economic entity assumption presumes that economic events can be identified specifically with an economic entity. 2. The going concern assumption anticipates that a business entity will continue to operate indefinitely. 3. The periodicity assumption allows the life of a company to be divided into artificial time periods to provide timely information. 4. The monetary unit used in U.S. financial statements is the U.S. Dollar.

What information regarding an entity's future cash flows are investors and lenders interested in?

1. Uncertainty 2. Timing 3. Amount

Which of the following are among the basic assumptions underlying U.S. GAAP?

1. going concern 2. monetary unit 3. economic entity 4. periodicity

On January 1, Jennifer purchased common stock of Gamma Corporation for $100,000. During the year, Gamma Corporation stock pays a dividend of $3,000. At the end of the year, Jennifer sells the Gamma stock for $104,000. What is the return on investment of the Gamma stock?

7%

Which of the following models is best in helping predict future cash flows?

Accrual Accounting

What accounting model best meets the primary goal of users of financial reporting?

Accrual Basis

Elements of Financial Statements

Assets, liabilities, equity, investments by owners, distributions to owners, comprehensive income, revenues, expenses, gains, losses

What accounting model produces a measure called net operating cash flow?

Cash Basis

What basis of accounting measures the difference between cash receipts and cash payments from transactions related to providing goods and services to customers during a reporting period?

Cash Basis

Faithful Representation includes:

Completeness Neutrality Free from error

Which of the following forms of business provide shares of stock as an ownership interest?

Corporation

What bases its measurements on the price that would be received in an orderly market transaction.

Fair Value

Generally Accepted Accounting Principles (GAAP)

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

Revenue

Inflows of assets or settlements of liabilities resulting from providing a product or service to a customer.

Corporations acquire capital from:

Investors in exchange for ownership interest. Creditors by borrowing - Either through individual loans or publicly traded debt such as bonds

Users of financial Information

Investors, creditors, employees, labor unions, customers, suppliers, government regulatory agencies, financial intermediaries

Expense Recognition Principle

Match expenses with revenues in the period when the company makes efforts to generate those revenues

Cash Basis Accounting:

Measurements of cash receipts and cash payments from transactions related to providing goods and services. Difference is net operating cash flow.

Accrual Basis Accounting:

Measurements of revenues and expenses, regardless of when cash is received or paid. Difference is net income or net loss.

What type of measurement model does U.S. GAAP currently employ?

Mixed Attribute

Cash flows from operations

Net Income - noncash items in net income (e.g., depreciation expense)

Comprehensive income is the change in equity of a business enterprise during a period from transactions and other events and circumstances from what type of sources?

Nonowner

FASB Accounting Standards Codification

Only source of authoritative nongovernmental U.S. GAAP -Organize the thousands of U.S GAAP pronouncements into roughly 90 accounting topics. -Also includes portions of SEC accounting guidance.

Relevance representation includes:

Predictive Value Confirmatory Value Materiality

Primary objective of financial accounting:

Provided information should be useful for decision making. Information should help investors & creditors evaluate the following characteristics of the enterprise's future cash receipts and disbursements: -Amounts -Timing -Uncertainty

Key variables in investment decision

Rate of Return Uncertainty of Risk

Revenue Recognition Principle

Record revenue in the period in which it's earned

Net Realizable Value (NRV)

The amount of cash into which an asset is expected to be converted in the ordinary course of business

What does it mean if information is cost effective?

The benefits of providing financial information exceed the costs of doing so.

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 rate.

Why do investors and creditors provide capital?

They want to earn a fair return on the resources they provide Shareholders receive cash from: Sale of the ownership shares of stock Periodic dividends

What is not a component of faithful representation as defined in the FASB's conceptual framework?

Understandability

The discounted cash flow valuation model

VE0 = CF1/(1+i) + CF2/(1+i)2+ CF3/(1+i)3... CFn/(1+i)n - VD0 where: VE0 = the value of common equity (per shares/stock) of the firm VD0 = the value of the net debt of the firm CFt = free cash flow of period t i = interest rate (reflects risk) t = time in years before the cash flow occurs It helps forecast cash flow from operations.

Recognition refers to the process of

admitting information into the financial statements

Measurement is the process of

associating numerical amounts with the elements

Financial Statements Include:

balance sheet, income statement, statement of cash flows, statement of shareholder's equity

The primary purpose of financial reporting is to provide useful information for decision making to providers of

capital

The qualitative characteristic of using the same accounting method each period over time refers to the concept of

comparability

Before they can be recognized, favorable items tend to require more verification than unfavorable items. Accountants refer to this as

conservatism

Suffered Corporation changed its inventory valuation method. Which characteristic is jeopardized by this change?

consistency

Cost effectiveness is a(n) on the accounting choices a company makes.

constraint

Which approach to measuring fair value determines fair value by estimating the amount that would be required to buy or construct an asset of similar quality and condition?

cost approach

The full disclosure principle requires that any information useful to decision makers be provided in the financial statements, subject to the

cost effectiveness constraint.

To enhance timeliness, how frequently does the SEC require its registrants to submit their financial information?

daily

The overriding objective in the hierarchy of qualitative characteristics of financial reporting information is

decision usefulness

Decreases in equity of a particular enterprise resulting from transfers to owners are called

disbursements to owners

Investors & creditors like to invest in stocks or bonds that provide a high

expected rate of return.

Under the accrual accounting model, the measure of resources sacrificed is called

expense

Financial information is conveyed through

financial statements and related disclosure notes

The FASB recently issued a standard that requires companies recognize revenue

for the amount the company expects to be entitled to receive at a point in time or over a period of time when goods or services are transferred to customers

What is not a component of relevance as defined in the FASB's conceptual framework?

free from error

Reporting assets at net realizable value helps predict:

future cash flows

Disclosure refers to the process

including additional pertinent information in the financial statements and accompanying notes.

Increases in equity of a particular business enterprise resulting from transfers to it from other entities of something of value to obtain or increase ownership interests is a(n)

investment by owners.

The application of conservatism leads to:

losses being recognized later than gains

Another term for equity is

net assets

Which of the following are acceptable measurement attributes for certain financial statement items?

net realizable value fair value historical cost present value of future cash flows

Historical Cost

original transaction value adjusted for depreciation and amortization

The measurement attribute based on future cash flows and the objective of approximating fair value in valuing an asset or liability is

present value

Accounting provides useful information about economic activity to help

produce good decisions and foster a prosper society

Providers of Financial Information

profit-oriented companies, not-for-profit entities, households

Capital Markets

provide a mechanism to help the economy allocate resources efficiently.

Investors and creditors are willing to provide capital to a corporation only if they expect to

receive more cash in return at some time in the future.

The hierarchy of qualitative characteristics of financial information require that, in order to be useful for decision making, information should possess the fundamental characteristics of

relevance and faithful representation

The accrual accounting model's measure of resources provided by business operations is called

revenues

Current Cost

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

Outflows or other using up of assets or incurrences of liabilities during a period from delivering or producing goods, rendering services, or other activities that constitute

the entity's ongoing major or central operations are referred to as expenses

The fair value approach that uses current information from recent transactions or exchanges in active trading on stock exchanges is

the market approach

Financial reporting refers to

the process of providing financial information to external users.

The previous requirement for revenue recognition, which dictated that the earnings process must be virtually complete and the collectability of the related assets reasonably assured was referred to as

the realization principle

Risk refers to

the uncertainty of an investment

Four different competent accountants independently agree on the amount and method of reporting on economic events. The concept demonstrated is:

verifiability