Intermediate Accounting 1 - Chapter 2

Mass Utility Co. is one of many public utilities that lists its property, plants and equipment before its current assets on the balance sheet

Industry Practice (Practical constraint)

Hierarchy of qualitative characteristics

-primary users of accounting information: capital providers (investors and creditors) and their characteristics -constraint: cost (what is the cost companies undertake to provide the information) -Pervasive criterion: decision-usefulness -Fundamental qualities: relevance and faithful representation - Ingredients of fundamental qualities: -(Relevance): Predictive value and/or confirmatory value and materiality - (Faithful Representation): Completeness and Neutrality and Free from error - enhancing qualities: comparability, verifiability, timeliness, understandability

A conceptual framework establishes the concepts that provide guidance on

All of the answer choices are correct: - identifying the boundaries of financial reporting -selecting the transactions, other events and circumstances to be represented - how transactions, events, and circumstances should be recognized and measured -how they should be summarized and reported

The objective of general-purpose financial reporting is to provide financial information about the reporting entity to

All of the following are correct: - investors - creditors - potential equity investors - other parties making decisions about providing resources to entity

A conceptual framework is necessary for which of the following reasons?

All of these answers are correct? - It allows the profession to quickly solve new and emerging issues -It increases financial statement users' understanding of and confidence in financial reporting - It enable standard setters to issue more useful and consistent pronouncements over time

Which of the following elements of financial statements describes amounts of resources and claims to resources at a moment in time?

Assets, Liabilities and Equity Investments by owners, revenues and comprehensive income describe transaction, events and circumstances that affect a company during a period of time

Which of the following describes amounts of resources or claims to resources at a moment in time?

Assets, liabilities, and equity

Black + Decker and Cannondale Corporation both use the FIFO cost flow assumption

Comparability

Duggan, Inc. is the only company in its industry to depreciate its plant assets on a straight-line basis. Which qualitative characteristic of accounting information may not be followed?

Comparability

Qualitative characteristics being employed when companies in the same industry are using the same accounting principles

Comparability

Quality of information that permits users to identify similarities in and differences between two sets of economic phenomena.

Comparability

Eastern Inc. uses the percentage of completion method to account for its long-term construction contracts, but its major competitors all use the completed contract method

Comparability is LACKING

Enhancing qualities of accounting information include all of the following:

Comparability, Verifiability, Timeliness, and Understandability

Enhancing qualities of accounting information include:

Comparability, Verifiability, Timeliness, and Understandability

Four qualitative characteristics that are related to both relevance and faithful representation

Comparability, Verifiability, Timeliness, and Understandability

Starbucks Corporation has used straight-line depreciation since it began operations

Comparability/Consistency

Includes all the information that is necessary for a faithful representation of the economic phenomena that it purports to represent

Completeness

A company uses a method to calculate its equipment depreciation that is in compliance with GAAP, however, it fails to disclose makers forecast future operations

Completeness is VIOLATED

Information about an economic phenomenon that corrects past of present expectations based of previous evaluations

Confirmatory Value

Quality of information that confirms users' earlier expectations

Confirmatory Value

What is the quality of information that enables users to confirm or collect prior expectations?

Confirmatory Value

An audited annual financial report can be used to confirm or correct prior expectations

Confirmatory value

Imperative for providing comparisons of accompany from period to period

Consistency / Comparability

Muruyama Corp. switches from FIFO to average-cost to FIFO over a 2-year period. Which qualitative characteristic of accounting information is not followed?

Consistency / Comparability

Within a five-year period, the Grant Company switched from FIFO to LIFO and then back to FIFO for the same items of inventory

Consistency is VIOLATED (part of comparability)

Identify the pervasive constraint developed in the conceptual framework

Cost Constraint

The economic activities of General Electric and its subsidiaries are merged for accounting and reporting purposes

Economic Entity

Each enterprise is kept as a unit distinct from its owner or owners

Economic Entity Assumption

Indicates that personal and business record keeping should be separately maintained

Economic Entity Assumption

The use of consolidated statements is justified

Economic Entity Assumption

The residual interest in the assets of a company that remains after deducting its liabilities is called

Equity (AKA ownership interest)

Yahoo! recognizes depreciation expense for a machine over the 2-year period during which that machine helps the company earn revenue

Expense Recognition

A company charges its sales commission costs to expense

Expense Recognition Principle

Allocated expenses to revenues in the proper period

Expense Recognition Principle

Intangible assets are amortized over periods benefited

Expense Recognition Principle

Rationale for accrual accounting

Expense Recognition and Revenue Recognition Principles

The monetary unit assumption is a part of GAAP but not IFRS

FALSE

The number of financial statement elements in the IFRS conceptual framework is equal to those in GAAP

FALSE

Under IFRS, it is mandatory to report property, plant and equipment at historical cost

FALSE

Users of financial statements are assumed to need no knowledge of business and financial accounting matters to understand information contained in financial statements

FALSE

Both GAAP and IFRS are increasing the use of fair value to report assets, but at this point GAAP has adopted it more broadly.

FALSE IFRS has adopted it more broadly

The objective of the conceptual framework is to provide financial information about the reporting entity primarily to company management and other internal users

FALSE Primarily to present to potential equity investors, lenders and other creditors in making decisions about providing resources to the entity

Fair Value Hierarchy

FASB has established a hierarchy to provide insight on the priority level of valuation techniques to improve comparability and consistency

Agricultural companies use fair value for purposes of valuing crops

Fair Value (Measurement Principle)

At the end of each year, Goshen Company records and reports its bonds payable at their market value

Fair value principles

Neutrality is an ingredient of this fundamental quality of accounting information

Faithful Representation

Quality of information that assures users that information represents the economic phenomena that that it purports to represent

Faithful Representation

The quality of information that means the numbers and descriptions match what really existed or happened is

Faithful Representation

The extent to which information is accurate in representing the economic substance of a transaction

Free from Error

The Debolla Corporation reports interest expenses at the end of the period as the amount of interest expense paid to its creditors less the amount of interest revenue it earns on CDs, bonds, and its receivables. GAAP requires the revenue and expense to be reported separately

Free from Error is VIOLATED

Oracle Corporation reports information about pending lawsuits in the notes to its financial statements

Full Disclosure

All significant post-balance-sheet events are disclosed

Full Disclosure Principle

Financial information it presented so that investors will not be mislead

Full Disclosure Principle

All important aspects of bond indentures are presented in financial statements

Full Disclosure Principles

Ensures that all relevant financial information is reported

Full Disclosure Principles

An increase in equity (net assets) arising from peripheral or incidental transactions is called a (n)

Gain

Walgreen Co. reports current and noncurrent classifications in it balance sheet

Going Concern

Depreciation and amortization policies are justifiable and appropriate only is we assume some permanence to the company because of the:

Going Concern Assumptions

Rationale why plant assets are not reported at liquidation value

Going Concern Assumptions

Fair value changes are not recognized in the accounting records

Historical Cost (Measurement Principle)

Goodwill is recorded only at time of purchase

Historical Cost (Measurement Principle)

Indicates that fair value changes subsequent to purchase are not recorded in the accounts

Historical Cost (Measurement Principle)

Gap, Inc. reports land on its balance sheet at the amount paid to acquire it, even though the estimated fair value is greater

Historical Cost (measurement)

On its financial statements, the Bristol Company reports its land at the value its acquired for

Historical cost principle

An item is not record because its effect on income would not change a decision

Materiality

Huge Corporation, a multibillion dollar company, has a policy of expensing the cost of all equipment that costs $1,000 or less in the period of purchase (regardless of its useful life) because it believes depreciation on such assets is not worth tracking

Materiality

An allowance for doubtful accounts is established

Measurement Principle and Expense Recognition Principle

In the conceptual framework for financial reporting, what provides "the how" - the implementation of accounting

Measurement, recognition and disclosure concepts such as assumptions, principles and constraints

Solectron Corporation, Inc. does not adjust amounts in its financial statements for the effects of inflation

Monetary Unit

Assumes that the dollar is the "measuring stick" used to report on financial performance

Monetary Unit Assumption

In the United States, inflation/deflation is ignored is accounting under which of the following assumptions?

Monetary Unit Assumption

Faithful Representation

NEED ALL 3 INGREDIENTS numbers, measures, or descriptions adequately represent the underlying phenomenon/item they are attempting to quantify, measure or describe information is faithfully represented if it has all of the following ingredients numbers in financials need to faithfully represent our want/true data

Absence of bias intended to attain a predetermined result or to induce a particular behavior

Neutrality

Assume that the profession permits the savings and loan industry to defer losses on investments it sells because immediate recognition of the loss may have adverse economic consequences on the industry. Which qualitative characteristic of accounting information is not followed?

Neutrality

Ignores the economic consequences of a standard or rule

Neutrality

The chairman of the SEC at one time noted, "If it becomes accepted or expected that accounting principles are determined or modified in order to secure purposes other than economic measurements, we assume a grave risk that confidence in the creditability of our financial information system will be undermined." Which qualitative characteristic of accounting information should ensure that such situation will not occur?

Neutrality

Joe Co. uses the straight-line methods of depreciation and always chooses the longest possible life in depreciating its plant and equipment. These are best cases scenario estimates by manufactures of the assets that are generally 30-40% longer than the manufacturer estimates of the average expected lives.

Neutrality is VIOLATED

Which of the following is among the ingredients of the fundamental quality of faithful representation?

Neutrality, free from error, and completeness

Free from Error

Numbers, amounts, and descriptions have been presented as accurately as feasible Note that accounting does involve the use of estimates and judgment (Ex: estimate of the useful life of equipment or the amount of uncollectible accounts, etc.) Can include putting items in the right accounts Face on financial statements = number is actually represented on financial statements Ex: If a company is in the business of producing and selling washing machines, but includes the value of those machines in property, plant, equipment (PP&E) instead of inventory on the balance sheet; the statements are NOT free from error

Generally, revenues are recognized when the:

Performance obligation is satisfied When a company satisfies the performance obligation to perform services or sell a product, revenue is recognized

The economic activities of FedEx Corporation are divided into 12-month periods for the purpose of issuing annual reports

Periodicity

Reporting must be done at defined time intervals

Periodicity Assumption

Separates financial information into time periods for reporting purposes

Periodicity Assumption

Information about an economic phenomenon that has value as an input to the processes used by capital providers to form their own expectations about the future

Predictive Value

Although it is not audited, an interim financial statement may help decision makers forecast future operations

Predictive value

Assets

Probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events

Information that is capable of making a difference in the decisions of users in their capacity as capital providers

Relevance

Predictive value is an ingredient of this fundamental quality of information

Relevance

Predictive value is an ingredient of which of the two fundamental qualities that make accounting information useful for decision-making purposes?

Relevance

Two fundamental qualities that make accounting information useful for decision-making purposes

Relevance and Faithful Representation

What are the two-fundamental qualities that make accounting information useful for decision-making?

Relevance and Faithful Representation

Norfolk Southern Corporation reports revenue in its income statement when the performance obligation is satisfied instead of when cash is collected

Revenue Recognition

Revenue is recorded when the product is delivered

Revenue Recognition Principle

A conceptual framework is a coherent system of concepts that flow from an objective

TRUE

Comprehensive income includes all changes in equity during a period EXCEPT those resulting from investments by owners and distributions to owners

TRUE

Relevance and faithful representation are the two fundamental qualities that make accounting information useful for decisions making

TRUE

Revenues are recognized in the accounting period in which the performance obligation is satisfied

TRUE

The IASB is considering a proposal to provide expanded guidance on estimating fair values

TRUE

The existing conceptional frameworks underlying GAAP and IFRS are very similar

TRUE

The historical cost principle would be of limited usefulness if not for the going concern assumption

TRUE

The objective of financial reporting is the foundation of the conceptual framework

TRUE

Having information available to users before it loses its capacity to influence decisions

Timeliness

Issuance of interim reports is an example of what enhancing quality of both relevance and faithful representation?

Timeliness

Motorola issues its quarterly reports immediately after each quarter ends

Timeliness

Watteau Inc. does not issue its first-quarter report until after the second quarter's results are reported. Which qualitative characteristic of accounting is not followed?

Timeliness

Sage issues its annual financial report nine months after the end of the annual reporting period

Timeliness is VIOLATED

Quality of information that allows users to comprehend its meaning

Understandability

ABC Company reports information in its financial statement notes that is confusing

Understandability is VIOLATED

Requires a high degree of consensus among individuals on a given measurement

Verifiability

Roddick Company has attempted to determine the replacement cost of its inventory. Three different appraisers arrive at substantially different amounts for this value. The president, nevertheless, decides to report the middle value for external reporting purposes. Which qualitative characteristic of information is lacking in these data?

Verifiability

The annual reports of Best Buy Co. are audited by certified public accountants

Verifiability

David Thomas combines his personal transactions and business transactions when he prepares his company's financial statements so that he can tell how well he is doing on an "overall" basis

Violates Economic entity

As soon as its purchases inventory, Sokolich Company records the purchase price as cost of goods sold to simplify its accounting procedures

Violates Matching Principles

Ebert Company prepares financial statements only every two years to reduce its costs of preparing the statements

Violates periodicity assumption and cost-benefit constraint

At the end of each year, Van Company reports its economic resources on a liquidation basis even though it is likely to remain in operation for many years

Violates the going concern assumtpion

Installment Method

a portion of each receipt is recognized as revenue payments spread out over time

Consistency

a type of comparability (subset of comparability after framework shifted) The same accounting policies and procedures are applied to similar economic items/events from period to period Internal comparison (consistent recording) When justified, companies can change their accounting methods under certain circumstances (such changes must be disclosed in the notes to the financial statements) **Rare because need a reason why to change** Ex: Depreciate the same assets using straight-line method one year and an accelerated method another year -> lack of consistency

Expenses Recognition Principle (Matching Principle)

all expenses incurred in generating revenue are recorded in the same period as that revenue (expenses are matched with the revenues they are related to) there are different approaches to recognizing an expense that depend on the nature of the expense

Completeness

all of the information necessary for faithful representation is provided all information is given Ex: A company has correctly calculated and reported the amount of its inventory and CCOGS for a period, but does not disclose the method used (Ex: LIFO, FIFO, etc.)

Monetary Unit Assumption

assumes that a monetary unit (Ex: US dollar) is used as the common unit of scale of measurement for financial reporting items note that price level changes (Ex: inflation and deflation) are ignored and the dollar is assumed to remain stable do NOT adjust for price level changes

Which of the following statements is true regarding the conceptual frameworks developed by FASB and IASB?

both have similar measurement principles based on historical cost and fair value

Comprehensive Income

change in equity (net assets) of an entity during a period from transactions and other events and circumstances from nonowner sources it includes all changes in equity during a period except those resulting from investments by owners and distributions to owners

Cost Constraint (Cost-Benefit Relationship)

collecting, processing, auditing, and communication of accounting information comes at a cost **MAIN CONSTRAINT** may be costs associated with disclosing information to competitors, potential litigation resulting from disclosure and analysis and interpretation of the information standard-setting organizations and government agencies must weight the perceived benefits of a particular piece of information against the cost to generate and communicate that information (before a standard is implemented, there must be a reasonable belief that the benefits of the standard outweigh its costs) Have to really consider if cost of providing additional information is worth the benefit of the business

entity perspective

companies are viewed as separate and distinct from the owners

In order to be relevant, financial information must be/have

confirmatory or predictive value Relevant information has predictive value or confirmatory value (or both) and is material

According to the conceptual framework, the usefulness of providing information in financial statements is subject to the constraint of:

cost-benefit Cost-benefit is the only constraint among the four answer alternatives When the cost of information exceeds its benefit, it should not be reported, even if it might be useful

Understandability

decision makers must understand the information within the context of the decision being made Ex: ABC company provides various schedules to support its financial statements. However, the schedules are difficult to read and cannot be easily traced back to the information in the financials

Losses

decreases in equity (net assets) from peripheral or incidental transactions of an entity and from all other transactions and other events and circumstances affecting the entity during a period except those that result from expenses or distributions to owners

Distribution to owners

decreases in net assets of a particular enterprise resulting from transferring assets, rending services or incurring liabilities by the enterprise to owners distributions to owners decrease ownerships interest (or equity) in an enterprise

Economic Entity Assumption

distinguishes between the activity of a business, its owners, and other businesses (business activity is separate from owner's activity) financial records and reports are prepared for each separate entity and the personal transactions of the owners are kept separate from the business they own (Ex: the personal residence of a business owner is not considered an asset of the corporation he/she owns) does not necessarily refer to legal entities as a parents and its subsidiaries are separate legal entities but they may be treated as one entity for accounting purposes through the consolidation (combination) of their financials (part of companies = children)

Comparability

enables users to identify and explain similarities and differences between economic phenomena compare financials of different companies (external comparison) You would lack comparability if following a different recording of transactions Ex: One company measures revenues based on the value of orders received from customers, while other company measures revenues based on the value of orders completed and delivered to customers

Decision Usefulness

financial reporting should provide information that helps users determine the amounts, timing and uncertainty of prospective cash receipts from dividends or interest and the proceeds from the sale, redemption or maturity of securities or loans

Full Disclosure

financial reports should include/disclose all information that could affect the judgment and decisions of an informed user of the reports information may be disclosed in one of the three places: financial statements, notes to the financial statements, supplemental reports financial reports should disclose all information that could affect the judgement of users (external users)

During Production (Percentage of Completion Method)

for certain long-term construction contracts, revenue may be recognized at various stages of the construction process based on the percentage of the job completed

Gains

increases in equity (net assets) from peripheral or incidental transactions of an entity and from all other transactions and other events and circumstances affecting the entity during a period except those that result from revenues or investments by owners

Investments by Owners

increases in net assets of a particular enterprise resulting from transfers to it from other entities of something of value to obtain or increase ownership interests (or equity) in it assets are most commonly received as investments by owners, but that which is received may include services or satisfactions or conversion of liabilities of the enterprise

Revenues

inflows or other enhancements of assets of an entity or settlement of its liabilities (or a combination of both) during a period from delivering or producing goods, rendering services, or other activities that constitute the entity's ongoing major or central oeprations

Materiality

information is material if omitting it or misstating it could affect users' decisions materiality is a relative term and is very specific to the company and has both a quantitative and qualitative aspect

Relevance

information is relevant if it is capable of making a difference in a decision to be relevant, information should have predictive value and/or confirmatory value and be material

Timeliness

information is timely if it is available before it loses its ability to influence decisions increased timeliness may come at the expense of other desirable qualities such as reliability increasing timeliness can be less reliable and less accurate get information is an exceptional amount of time from when recorded Ex: XYZ company provides potential investors with its March 31st quarter and financial statements on April 15 and thus information timely

Verifiability

information is verifiable when independent measures (ex: accountants), using the same measures, obtain similar results there would be a consensus among different measurers using the same measurement methods confirm something is recorded correctly (where confirmatory is where you confirm previous financial expectations) Ex: The historical cost of an asset (Ex: the cost of a machine or building) is verifiable in that any measurer looking at the related purchase and sale documents should all identify the same cost

Neutrality

information must be unbiased in that it does not favor a particular viewpoint or party over another it should be factual, truthful, and complete Ex: Not giving information that skews the reader's opinion of the company Ex: Consider a company that does not clearly disclose significant product liability lawsuits on the face of the financials or in the notes to the statements. These financials are biased in favor of the company and create an overly positive picture of the company to readers/users of the statements

Confirmatory value

information that enables decision makers to confirm or correct prior expectations Ex: Financial statements generated at the end of the current fiscal year confirm our expectations about the company's financial condition, revenue and cash flows for the year

Predictive value

information that helps users form expectations about the future make predictions about going forward Ex: A quarterly set of financial statements for the first quarter of this year along with last year's quarterly and annual statements, are often useful in making predictions about a company's financial condition and its ability to generate cash and revenues for the current fiscal year

primary users

investors and creditors are identified as the primary users of the financial statements

Fair Value Principles

market-based measured defined as 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 use of fair value in the standards has been increasing in recent years and is now an option as the basis for the measurement of financial instruments such as receivable, investments and debt securities market value at any given time **UNDER IFRS FAIR VALUE CAN ALSO BE APPLIED TO PP&E, NATURAL RESOURCES AND SOME INTANGIBLES - NOT TRUE UNDER GAAP** more useful than historical cost for certain types of assets/liabilities (ex: marketable securities) and in certain industries (ex: brokerage firms) fair value is often more RELEVANT than historical cost as it reflect the current cash equivalent value of financial instruments Ex: Marketable securities that the company intends to sell in the short-term are valued at their current market value (Ex: fair value) on the balance sheet Fair value of stock and equipment look up on internet for current price (if not available appraisal or Board of Directors will determine)

Quantitative aspect

materiality can be judged in terms of a quantitative threshold such that any amount above the threshold is considered material relative size rather than absolute size is more important in determining materiality threshold value is left to the subjective judgement of the company and its auditors (general rule of thumb often followed by auditors says that any amount that is 5% or more of net income is probably material) Ex: Uncollectible receivable of $10,000 is likely material for a company that has net income of $100,000 (Ex: 10%), but not for a company that has net income of $10,000,000 (0.01%)

Supplemental reports

may include information such as: - more detailed information that supports the financial statements -additional information that may be very relevant but low in reliability -management's discussion and analysis of the financial statements

Companies that use IFRS

may report property, plant and equipment and natural resources at fair value

Industry practices (A practical constraint)

not part of the conceptual framework some types of accounting information are important for decision making related to one industry but not another selective exceptions to GAAP and general accounting theory may be permitted for industry specific peculiarities assuming there is a clear precedent within the industry (Ex: a clear industry standard) SOMETIMES EXCEPTIONS TO STANDARDS Ex: Most companies record inventory at cost, but agricultural crops are recorded at their net realizable (market) value due to the difficulty of determining actual cost

Point of Sale

occurs when the goods/services are shipped/delivered (ex: title is transferred) to the buyer revenue can be recognized

Expenses

outflows or other using up of assets or incurrences of liabilities (or a combination of both) during a period from delivering or producing goods, rendering services, or carrying out other activities that constitute the entity's ongoing major or central operations

Liabilities

probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events

Notes to the financial statements

provide additional insights about company operations and explain items presented in the financial statements the information can be quantitative or qualitative and may be presented in narrative form or in schedules/charts Examples: - descriptions of accounting policies -methods used in measuring the elements of the financial statements (ex: depreciation method and inventory costing method) -contractual agreements and pending litigation -explanations of uncertainties/contingencies

Enhancing Qualities

qualitative characteristics that are complementary to the fundamental qualities and distinguish more useful information from less useful information complementary to relevance and faithful representation helps distinguish information from more relevant to less

Qualitative Aspect

qualitative factors and the nature of the item must also be considered Ex: An illegal transaction may be considered material even if it is of relatively smaller dollar amount (Ex: the illegal $1,000 payment to a foreign governmental official to secure a contract)

this quality can be defined as the capacity to make a difference in a decision

relevance

Fundamental qualities

relevance and faithful representation (two primary fundamental qualities that make accounting information useful for decision makers)

Historical Cost Principle (AKA Cost Principle)

requires that many assets and liabilities be recorded/reported on the basis of their acquisition cost/price (report the value of an item based on original cost/price) liabilities are recorded at the value of the assets or services initially received in exchange for the liability (Ex: amount of cash received in exchange for a bond or the value of a service provided in exchange for an account payable) this value is generally adjusted only when the item is consumed, sold, or liquidated/removed (Ex: depreciation reduces the value of an asset as it is consumed over time) other valuation methods such as market value are often less RELIABLE (Ex: Historical cost doesn't change and can easily be verified using purchase records. However, the market value of an asset changes regularly and is not always easy to determine and verify) Ex: Companies record the value of inventory on the balance at the acquisition cost of the inventory of the cost to produce the inventory

Equity

residual interest in the assets of an entity that remains after deducting its liabilities; in a business enterprise, the equity is the ownership interest

Cost-recovery Method

revenue is not recognized until the cost of the product has been recovered after receiving costs

Revenue Recognition Principle

revenue may be recognized (Ex: formally recorded/reported) when both realized AND when earned

Periodicity Assumption

since external users need periodic information on a timely basis to make decisions this assumption requires the economic life of an enterprise be divided into artificial time periods for financial reporting most common time periods used are monthly, quarterly, and yearly (many believe given technological advances, more immediate online/real-time financial information should be available) a trade-off that exists between the increased relevance provided by more timely information and the reliability of that information divide time into periods to meet all concepts (timeliness and relevance)

Cost constraint

the benefit of having useful information must be weighed against the cost to obtain it

Decision-usefulness

the characteristics outlined below distinguish more useful from less useful information

Under IFRS

the existing conceptual framework is very similar to the conceptual framework under GAAP IFRS companies may apply fair value to natural resources Monetary unit assumption is still used (although the unit of measure will vary depending on the currency used in the country in which the company is incorporated)

Constraints

the financial statements and their elements are most informative when they possess the specific qualitative characteristics above, subject to the cost constraint below

Financial Statements

the formal reports required by GAAP, including the balance sheet, income statement, statement of changes in owner's equity and statement of cash flows an item should be disclosed in the body of the financial statements if it meets the definition of a basic element, is measurable with sufficient certainty, relevant, and reliable

What is the conceptual framework intended to establish?

the objectives and concepts for use in developing standards of financial accounting and reporting Concepts statements (also collectively called the Conceptual Framework) provide the general underpinnings for specific GAAP In a way, it's a constitution for developing specific accounting principles Concepts statements are NOT GAAP

Recognition

the process of admitting/recording information into the basic financial statements putting it into our books in order to be recognized, an item (Ex: an events or transactions) must meet the definition of an "element of financial statements" as defined by SFAC 6 and it must be measurable

Realization

the process of converting non-cash assets into cash or rights to cash revenue is REALIZED when goods, services, merchandise or other assets are converted to cash revenues are realizable when assets received or held are readily convertible to cash determine if we will have a reasonable exchange ending in cash being given

Measurable

the process of quantifying financial statement elements of stating them in terms of numerical amounts able to quantify it numerically to get into records

Conceptual Framework

through an issuance of a number of Statements of Financial Accounting Concepts (SFAC) **not a standard**, the FASB created a conceptual framework that provides structure and direction to financial accounting and reporting (provides foundation/framework for standards) provides a basis for the creation of accounting standards, but does not directly prescribe GAAP

Basic Objective of Financial Accounting

to provide financial information about the reporting entity that is useful to present and potential equity investors, lenders, and other creditors in making decisions in their capacity as capital providers

Going Concern Assumption

unless there is evidence to the contrary, it is assumed that a business entity will continue into the foreseeable future and will be able to meet its objectives and commitments critical to many broad and specific accounting standards (Ex: provides justification for classifying assets and liabilities as long-term vs. short-term and measuring assets based on their historical costs rather than at liquidation values) justifies depreciation/amortization and accruals/deferrals financial statements are put together through this assumption

Measurement Principle

various ways to measure values various measurement bases are allowed 2 most common: historical cost and fair value

A company's auditors come up with a different value for an asset than the amount reported by a company in its financial records

verifiability (enhancing quality)

Every year, the Litchfield Company puts together its financial statements in dollars and then adjusts them to reflect any increase or decrease in purchasing power due to inflation/deflation

violates the monetary unit assumption

Guthrie Inc. sells on account and record revenue at that time, even though it knows that collection is highly uncertain and very significant efforts have been made to collect the accounts

violation of revenue recognition principles

Systematic rational allocation

when an asset is acquired/purchased that will be used in operations over more than one period, the cost is spread over the anticipated benefit period using a systematic rational allocation method that in effect matched the cost of the asset with the revenues it helps generate Ex: the cost of a long lived asset such as plant and equipment is matched to revenue by depreciating (ex: depreciation expense) over its useful life

End of Production (Completed Contract Method)

when dependable estimates of costs and progress on a long-term construction contract cannot be reasonably assessed, then revenue recognition may take place at the end of production (ex: when the job is completed)

Delayed recognition - After delivery

when recognition is delayed until cash is received NOT used if individual is NOT credible

Advanced Recognition - Before Delivery

when revenue is considered earned but not yet realized

In the period incurred (Period costs)

when the connection between a cost and revenue cannot be determined, it is treated as an expense in the period in which it is incurred Examples: - General and administrative expenses = officers' salaries, wages of support staff, insurance and taxes on administrative offices, etc. - selling expenses = advertising and marketing

Earned

when the entity has substantially completed what it must do to be entitled to benefits (Ex: assets) generated by the revenues

Cause and effect relationship

when there exists a direct cause and effect relationship between revenue and an expense Examples: 1) Product costs (Easy to track) -Direct Materials = when a product such as a computer is sold, the cost of the direct material used to make the computer is expensed when the revenue from the sale of the computer is recognized -Direct labor = the wages paid to the worker(S) for their time spent assembling the computer are also expensed at the same time 2) Direct Period Costs - Sales commissions = there is a direct relationship between the cost of commissions paid to computer sales people and the revenue generated by the sale - Shipping costs = similarly there is a direct relationship between product shipping costs and revenues produced by the products sold

Possible recognition points

while revenue is generally recognized when it has been earned and realization has occurred (ex: the point of sale), it may also be advanced or delayed