Intermediate Accounting 1 Exam 1

Resource Allocation

Financial accounting provides information that enables users to evaluate economic entities and make efficient ________ _______ decisions based on the risks and returns of a particular investment. This process directs capital flows to their most productive uses.

Accural

Financial accounting uses _____ accounting rather than Cash accounting.

1. predictive value 2. confirmatory value 3. materiality

Financial information is relevant if it is capable of making a difference in decision making by exhibiting the following three attributes?

compare

Financial statement users rely on the accounting policies footnote to ________ firms within the same industry.

Accrual Accounting

Firms recognize revenues according to the revenue recognition principle and recognize expenses according to the expense recognition concept, regardless of when they receive or pay the cash.

Financial Accounting Standards Board Accounting Standards Codification (ASC)

Groups and summarizes all current accounting standards by topic. Divided into topics, subtopics, sections, and paragraphs Nine major topics. Subtopics are generally distinguished by area or scope. Sections uniform across subtopics.

Predictive Value

Information has a ________ ________ if decision makers can use it as an input into processes that help forecast future outcomes.

Neutral

Information is ______ if it is free from bias in both the selection and presentation of financial data.

Material

Information is _______ if reporting it inaccurately or omitting it would affect financial statement users' decisions.

Free from error

Information is reported ______ ______ ______ when there are no mistakes or omissions in the description of an event or in the process used to produce the financial information.

Level 2

Inputs other than the quoted prices included in level 1 that are observable for the asset or liability.

Compound Interest

Interest computed on both the principal and the interest left on deposit is referred to as _____ _____.

Professional skepticism

Is "an attitude that includes a questioning mind and a critical assessment of audit evidence."

Groupthink Bias

Is a phenomenon that occurs in situations where members of a group, in an attempt to avoid conflict, reach a consensus decision without considering all of the reasonable alternatives.

Annuity

Is a series of periodic payments or receipts of equal amounts that occur at equal time intervals between each cash flow.

Economic Entity Tax Code?

Is an organization or unit with activities that are separate from those of its owners and other entities. Financial information always relates to a particular _____ _____.

Financial Information

Is information that is or is not governed by rules set forth by the accounting standard-setting bodies. Firms prepare financial statements and the footnotes based on accounting standard setter's rules. This helps investors make decisions.

Financial Accounting Foundation (FAF)

Is responsible for the oversight, administration, and finances of the FASB. They obtain funds primarily through the PCAOB.

Fair value

Is the amount at which an asset (or liability) could be bought (or incurred) or sold (or settled) in a current transaction between willing parties.

Historical Costs

Is the amount of cash (or equivalent) that the firm paid to acquire the asset.

Current Market Value

Is the amount of cash that the firm would receive by selling the asset in an orderly liquidation.

Current Cost

Is the amount of cash that would be required if the firm acquired the asset currently.

Net Realizable Value

Is the amount of cash to be received in exchange for an asset, less the direct costs of disposal.

Financial Accounting Standards Board (FASB)

Is the body responsible for promulgating U.S. GAAP.

Simple Interest

Is the initial investment multiplied by the stated interest rate for a single period and the amount of time (in terms of the number of periods) the investment is held.

Judgment

Is the process by which an accountant or manager reaches a decision in situations in which there are multiple alternatives.

Financial Accounting

Is the process of identifying, measuring and communicating financial information about an economic entity.

Recognition

Is the process of reporting an economic event and is included in the financial statements (and not as a note to the accounts).

The Accounting Standards Codification or just Codification

Is the single source of GAAP in the United States and includes all pronouncements issued by any of the standard-setting bodies that have not been superseded.

Overconfidence Bias

Is the tendency to be more confident than your abilities and experience level would objectively warrant.

Availability Bias

Is the tendency to use the data that are most readily available or most easily recalled to make a decision, as opposed to considering all relevant data.

Future Value

Is the value at some specified point in the future of a cash flow or a series of cash flows to be paid or received between the current date and the specified point in the future.

Present Value

Is the value today of a cash flow or a series of cash flows to be received or paid in the future.

Confirmatory Bias

Is when decision makers under-weight information that is not consistent with their initial beliefs.

fundamental and enhancing

The conceptual framework divides the qualitative characteristics into _______ characteristics and ______ characteristics.

Periodicity assumption

The entity is to divide its life into artificial time periods for the purpose of providing periodic reports (e.g., Income Statement) on its economic activities. For example, the SEC requires quarterly financial statements.

Time Value of Money

Means that a dollar received today is worth more than a dollar received at some time in the future. This statement is true because a dollar received today can be invested to provide a return.

Authoritative Literature Levels GAAP Level 3

Non-authoritative: Concepts, IFRS, AICPA Publications, industry Practice

recognized

Note that an item could meet all four elements but not be _______ due to the cost-benefit constraint or a materiality threshold.

Earnings management

Occurs when managers manipulate financial information and misrepresent the firm's financial position and performance.

Anchoring Bias

Occurs when the decision maker focuses on one piece of information (often the first piece of data encountered), weighting it more heavily than other pieces of information.

Suppliers and Customers

Organizations that provide the necessary inputs for the products or service produced by the entity and companies or individuals that purchase the goods or services from the entity.

1. Financial information 2. Economic entity 3. User groups 4. Legal, economic, political, and social environment

The financial accounting definition contains four major elements, what are they?

1. Financial statement preparers 2. External and internal auditors 3. Accounting standard setters, such as the FASB and IASB 4. Regulatory bodies, such as the SEC and PCAOB 5. Professional organizations, such as the AICPA

Other Parties Involved in the Preparation and Use of Financial Information?

Expenses

Outflows or other consumption of assets or incurrences of liabilities (or a combination of both) from delivering or producing goods, rendering services, or carrying out other activities that constitute the entity's ongoing major or central operations.

Accounting Policies Footnote

Part of the financial statements that describe the portfolio of accounting choices. It is typically one of the first notes to the financial statements, and indicates where managers used judgment in the financial reporting process.

American Institute of Certified Public Accountants (AICPA)

Prepare and grades the Uniform CPA Examination.

Assets

Probable future economic benefits controlled by an entity as a result of a past transaction.

Liabilities

Probable future sacrifices of economic benefits arising from a present obligation as a result of a past transaction.

Regulatory Bodies

Protect investors and oversee the accounting standard-setting process.

Cost Constraint

Providing all relevant and representationally faithful information available is costly.

General Purpose Financial Statements

Published financial statements that provide information to a wide spectrum of user groups: investors, creditors, financial analysts, customers, employees, competitors, suppliers, unions, and government agencies.

Level 1

Quoted prices in active markets for an identical asset or liability. A publicly traded equity security is classified in this level.

1. Historical Costs 2. Current cost 3. Current market value 4. Net realizable value 5. Present value of future cash flows

5 bases of measurement?

Compare

A company's financial information is useful if users can ______ with other companies.

Warranty Liabilities

A company's promise or guarantee to repair or replace any defective goods for a specified period of time after the date of purchase.

Leases

A contract that gives someone the right to use the asset, legally owned by someone else, for a specified period of time in return for periodic payments.

Notes Receivable

A formal written promise to receive a fixed sum of money at a specified date (or dates) in the future, usually with a stated interest rate.

Basis for Conclusion

Are discussions of the Board's reasoning and thought process used to create the standard. They are not authoritative. (FASB)

Internal Auditors

Are employees of the company serving in an advisory role to management and providing information regarding the company's operations and proper functioning of its internal controls.

External Auditors

Are independent of the company and are responsible for ensuring that management prepares and issues financial statements that comply with accounting standards and fairly present the financial position and economic performance of the company.

Cognitive Biases

Are systematic deviations from rationality, to which we are all subject, that can impact judgments on a day-to-day basis.

Fundamental characteristics

Are those basic characteristics that distinguish useful financial information from information that is not useful.

Expense Recognition Principles

Are used to determine the period when a company reports an expense on the income statement.

management manipulation

Areas of financial reporting requiring significant judgments are susceptible to ______ ______. Example: Management bonuses tied to net income.

Chapter 1

Chapter 1

Chapter 2

Chapter 2

Chapter 3

Chapter 3

Chapter 7

Chapter 7

Authoritative Literature Levels GAAP Level 1

Codification & SEC Rules

Bright Line Tests

Tests that require meeting a pre-established numerical threshold.

manipulation

The cash basis provides an opportunity for the ______ of net income by altering the timing of cash flows (e.g., by delaying payment for inventory purchases).

Comprehensive income

The change in equity of a business enterprise during a period from transactions and other events and circumstances from non owner sources. It includes all changes in equity during a period except those resulting from investments by owners and distributions to owners.

Understandability

The classification of the elements of the financial statements allow for better understanding.

Competitors

Companies that produce the same service or product.

Rules Based Standard

Contains specific, perspective procedures rather than relying on a consistent theoretical framework.

Fair Value Hierarchy

Developed by FASB and IFRS require disclosures indicating the reliability of the inputs to measure the value indicated in the financial statements. The three levels are the following: Level 1: Quoted prices in active markets Level 2: Comparable pricing Level 3: Unobservable inputs

1. Corporations 2. Partnerships 3. Sole Proprietorships 4. Governmental Organizations

Economic Entities can be what four things?

Privately or Publicly

Entities can also be ______ held or ______ held.

Creditors and other debt investors

Entities including banks and other financial institutions that lend money to the company either through a private agreement or through public debt offering.

Sales revenue, depreciation expense, and dividends

Example of period-of-time elements?

Accounts receivable and accounts payable

Examples of point-in-time elements?

Financial Accounting Standards Advisory Council (FASAC)

Exists to advise the FASB on technical issues.

matched

Expenses should be ______ with revenues, expensed in the period incurred, or systematically allocated over its period of use.

Reactive Factors

External factors are what?

Same

FASB and IFRS have the ______ point in time elements.

Objective Oriented Standard

Falls right in the middle between rules based and principles based.

Proactive

Financial accounting is ________ in that it can change or influence its environment by providing feedback information that is used by organizations and individuals to reshape the economy.

Faithful Representation; complete, neutral, and free form error.

The second fundamental characteristic, indicates whether financial information depicts the substance of an economic event in a manner that is _____, ______ ,and _____ ____ ____.

Complete

The section of an economic event is considered ______ if it includes all information, both descriptions and explanation, necessary for the financial statement user to understand the economic event.

1. Investments by owners 2. Distributions to owners 3. Revenues 4. Gains 5. Expenses 6. Losses 7. Comprehensive income

The seven period-of-time elements (Statements of Retained Earnings and Income Statement) are?

1. Establish and understand the facts 2. Identify the issue 3. Search the authoritative literature 4. Evaluate the results of the search 5. Develop conclusions 6. Communicate the results of the research

The six steps in Financial Accounting Research Process are?

1. Assets 2. Liabilities 3. Equity

The three point in time elements are?

1. Financial capital maintenance 2. Physical capital maintenance

The two concepts of capital maintenance adjustments?

1. Recognition 2. Revenue recognition 3. Expense recognition 4. Bases of measurement

The underlying principles of Accrual accounting are what?

- Financial accounting reacts to pressure (lobbying) from various groups and changes in its environment. - Accounting theories and procedures evolve to meet the dynamic changes and demands from the environment. - Accounting conforms to economic conditions, legal standards, and social values.

Types of reactive factors?

Level 3

Unobservable inputs to value the asset or liability.

income-increasing or income-reducing

Users can determine whether a company employs _________-________ or _______-_______accounting policies or methods.

estimates

Many of the balances reported on financial statements are _______.

Allocate Resources

Accounting information is used to ________ ______ efficiently throughout the economy by directing capital flows to their most productive uses.

1. Factors that may influence management to intentionally bias their estimates 2. Cognitive biases 3. Complexity of the business environment and transactions

Accountants face a number of potential impediments to the use of good judgment such as?

1. Reduce comparability between firms. 2. Result in differences within a firm over time.

Accounting standards allow management discretion in selecting accounting methods, applying those methods, and changing methods or estimates. This can 1. ? 2. ?

Managerial Behavior

Accounting standards can also influence ______ ______. For example, expensing research and development costs may slow investment in research during economic downturns because this accounting treatment results in lower earnings figures.

revenue and expense

Accrual accounting recognizes non-cash transactions. Therefore, the big difference between the two methods lies in the timing of ______ and _______ recognition.

Government Agencies

Agencies representing the government that are in charge of reviewing and/or regulating the company.

Monetary unit assumption

All items are valued according to an accepted currency (e.g., U.S. $), and it is assumed that the currency remains stable over time in terms of purchasing power.

Comparability

Allows financial statements users to identify and understand similarities and differences among several entities. Compare entities for capital allocation decisions.

Verifiability

An amount can be verified.

1. The entity's economic benefits are consumed in the process of producing or delivering goods or rendering services (e.g., Wages Expense), or 2. An asset has experienced a reduced future benefit or a liability has been incurred without an associated economic benefit (e.g., expiring Prepaid Rent).

An expense is recognized when the following occur...

Realized or Realizable

An item is _____ or ______ when a company exchanges a good or service for cash or claims to cash.

Emerging Issues Task Force (EITF)

Assets the FASB by addressing issues that are not as broad scope as those found on the FASB's agenda.Items often on their agenda include industry specific issues.

Going-concern concept

Assumes the entity will continue to operate indefinitely (i.e., not go into liquidation in the near future).

1. Going concern concept 2. Business or economic entity concept 3. Monetary unit assumption 4. Periodicity assumption

Assumptions of financial reporting?

Enhancing Characteristics

Attributes that help determine when information is relevant and representationally faithful.

professional skepticism

Auditors must exercise _______ ______ to minimize management bias.

Authoritative Literature Levels GAAP Level 2

Authoritative Rules & Principles from FASB & predecessors

Asset/Liability (balance sheet) Approach

Basing the decision on whether an economic resource is received and it meets the definition of an asset, such as accounts receivable is an _______ _________.

Do not

Both U.S. GAAP and IFRS _____ _____ allow a cash-basis system.

Financial capital maintenance

Capital is viewed as the financial amount, or money amount, invested in a company.

Physical Capital Maintenance

Capital is viewed as the productive capacity of a company, such as units of output per day.

Bonds

Debt instruments typically issued for a period greater than a year to raise capital that requires the debtor to repay the principal balance at a specified date in the future.

Losses

Decreases in equity (net assets) from an entity's peripheral or incidental transactions and from all other transactions and other events and circumstances affecting the entity except those that result from expenses or distributions to owners.

Distributions to owners

Decreases in equity of a particular business enterprise resulting from transferring assets, rendering services, or incurring liabilities by the enterprise to owners. This element decreases ownership interest (or equity) in an enterprise.

Accounting Standard Setters

Develop and promulgate accounting concepts, rules, and guidelines that provide information that is relevant and faithfully represents the financial and economic position of an entity.

1. Performance (e.g., Profit) 2. Income (includes Revenues and Gains) 3. Expenses (includes Expenses and Losses) 4. Capital Maintenance Adjustment (e.g., Restatements/Revaluations of assets and liabilities)

IFRS has only four period of time elements, what are they?

Publicly

If the entity is _____ held, then its equity can be bought and sold by external parties on stock exchanges.

Confirmatory Value

Information has a ______ ______ if it provides feedback about prior evaluations.

Revenue Recognition Principle

In the conceptual framework states that a company should recognize revenue when it is realized or realizable and earned.

Gains

Increases in equity (net assets) from an entity's peripheral or incidental transactions and from all other transactions and other events and circumstances affecting the entity except those that result from revenues or investments by owners.

Investments by owners

Increases in equity of a particular business enterprise resulting from transfers to it from other entities of something valuable to obtain or increase ownership interests (or equity) in it. Owners can receive assets as investments by providing goods and services and by satisfaction or conversion of liabilities of the enterprise.

Financial Analysts

Individuals employed at investment banks, commercial banks, and brokerage houses that use financial information to provide guidance to individuals and other entities in making investment and credit decisions.

Employees and Labor Unions

Individuals that work for the company and the organizations that represent the employees' interests.

Revenues

Inflows or other enhancements of an entity's assets or settlements of its liabilities (or a combination of both) from delivering or producing goods, rendering services, or other activities that constitute the entity's ongoing major or central operations.

best

Judgment should be used to report the substance of a transaction in a manner that _____ reflects economic reality.

assumptions

Many amounts reported on the financial statements are based upon _______.

1. meets the definition of an element 2. is measurable 3. is reliable 4. is relevant.

Recognition occurs when the item meets what four things?

Income Statement Approach

Recording based on revenue recognition criteria involves an ______ ______ _______.

Securities and Exchange Commission (SEC)

Regulates publicly traded companies.

Principles Based Standard

Relies on theories, concepts, and principles of accounting that are linked to a well-developed theoretical framework.

Point-in-time elements

Represent resources, claims to resources, or interests in resources as of a specific point in time and appear on the balance sheet (statement of financial position).

Period-of-time elements

Represent the results of events and circumstances that affect an entity during a period of time and appear on the income statement, statement of comprehensive income, or statement of shareholders' equity.

Materiality threshold

Requires that an item be recognized in the financial statements if its omission or misstatement would significantly influence the judgment of a reasonably informed statement user.

Cost benefit constraint

Requires that the expected benefits from recognition exceed the costs of recognition.

Capital Maintenance Adjustments

Restatements or revaluations of reported amounts of assets and liabilities that companies usually report in comprehensive income.

Present Value of Future Cash Flows

Results from discounting net cash flows the firm expects to receive on the exchange of an asset, or to pay to liquidate a liability.

Earned

Revenues are considered ______ when the seller has accomplished what it must do to be entitled to the revenues.

Pensions

Separate legal entity called to which a company (referred to as the sponsor company) sets aside funds for future benefits. The trust accumulates the fund assets and makes payments to retirees.

Governmental Accounting Standards Advisory Council (GASAC)

Serves as an advisory board to the GASB.

International Accounting Standards Board (IASB)

Sets International Financial Reporting Standards (IFRS).

Public Company Accounting Oversight Board (PCAOB)

Sets auditing standards and oversees the audits of public companies in the U.S.

Conceptual Framework

Sets forth theory, concepts, and principles to ensure that accounting standards are coherent and uniform.

Governmental Accounting Standards Board (GASB)

Sets standards for state and local governmental units.

Equity Investors

Shareholders of the company.

relevance; faithful representation

The FASB identifies the two fundamental characteristics as ______ and ________ _______.

1. Standards & Interpretations 2. Authoritative Rules 3. Conceptual Framework 4. Other standard setting bodies

The IASB includes four categories of standards in IFRS, what are they?

second phase

The _______ _______ of the conceptual framework project focuses on the elements of financial reporting.

Management

The ________ of a particular economic entity prepares its financial information, including the financial statements.

Market Participant Demand

The form, content, and extent that firms provide financial information is based on ________ _______ _______.

Timeliness

The information is timely enough to be useful for decision making.

compounding; discounting

The process of moving from the PV to the FV is known as ________. The process of moving from the FV to the PV is known as ________.

Equity

The net assets of the business (assets minus liabilities).

Business or Economic Entity concept

The owner(s) and the business affairs are separated and reported separately. Have Tax ID Number.

Cash basis

This method recognizes revenues when the cash is received and expenses when the cash is paid.

- A move toward a less rules-based (or a more principles-based) system as found in IFRS. - A move toward standards that are focused on the asset/liability approach. - A move toward measuring balance sheet items at fair value, rather than historical cost.

Three Current Trends in Standard Setting?

Objective of Financial Reporting

To provide financial information about the reporting entity that is useful to existing and potential investors, lenders, and other creditors in making decisions about providing resources to the entity.

Private Company Council (PCC)

Was established to set accounting standards for U.S private companies.

1. The balance sheet 2. The statement of comprehensive income 3. The statement of cash flows 4. The statement of shareholders' equity

What are the four basic financial statements?

1. Objective of financial reporting 2. Characteristics associated with high-quality accounting standards 3. Elements of the financial reporting system 4. Recognition and measurement criteria

What are the four conceptual framework components?

1. comparability 2. verifiability 3. timeliness 4. understandability

What are the four enhancing characteristics?

- The four basic financial statements - Financial Accounting Standards Board - A letter to the shareholders - A formal discussion and analysis of the firm by the management of the firm - Management report - Auditors' report - Financial summary

What are the sources of financial information?

Step 1: Identification of an issue Step 2: Decision to pursue Step 3: Public meetings Step 4: Exposure Draft Step 5: Public roundtables Step 6: Redeliberation Step 7: Publication of the final standard

What is the seven step FASB standard setting process?

Analysts' forecasts

______ ______ may also influence management's judgment.

Research

______ is the systematic investigation into an issue.

Cognitive biases

_______ ______ can impact the way accountants make judgments.