Intermediate Accounting - Chapter 2

Neutrality

(Faithful Representation) A company cannot select info to favor one set of interested parties over another. Ex: R.J. Reynolds should not suppress info about lawsuits that have been filed related to tobacco-related health concerns, even though it may be damaging to the company.

Completeness

(Faithful Representation) All information that is necessary for faithful representation is provided. Ex: Citigroup fails to provide information needed to assess the value of its subprime loan receivables, info is not complete.

Free From Error

(Faithful Representation) Allows the most accurate representation of a financial item. Ex: JPMorgan Chase misstates its loan losses, the f.s. are misleading and not a faithful representation. Ex: management must estimate the amount of uncollectible accounts to determine bad debt expense

Predictive Value

(Relevance) Has value as an input to predictive processes used by investors to form their own expectations about the future. Ex: UPS analyzes current resources to claim the resources, dividend payments.

Confirmatory Value

(Relevance) Helps users confirm or correct prior expectations. Ex: UPS issues year-end financial statements, then confirms or changes past or present expectations based on previous evaluations.

Materiality

(Relevance) Omitting or misstating this info could influence decisions that users make on the basis of the reported financial information. Ex: Sunbeam allegedly made many immaterial adjustments that added up to a material misstatement that misled investors about the company's financial position.

Four Basic Assumptions

Economic Entity Going Concern Monetary Unit Periodicity

Economic Entity Assumption

Economic activity can be identified with a particular unit of accountability. In other words, a company keeps its activity separate and distinct from its owners and any other business unit. Ex: Panera record's the company's financial activities separate from those of its owners and managers Ex: GE & its subsidiaries merge for accounting and reporting purposes

Timeliness

Having info available to decision makers before it loses its capacity to influence decisions Ex: If Dell waited to report its interim results until nine months after the period, the info would be less useful for decision making purposes.

Periodicity (Time Period) Assumption

Implies a company can divide its economic activities into artificial time periods.

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 also include services or satisfaction or conversion of liabilities of the enterprise.

Revenues

Inflows or other enhancements of assets of an entity or settlement of its liabili- ties (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 operations.

Comparability

Info is measured and reported in a similar manner for different companies and is considered comparable. Ex: accounting for pensions in Japan differed from US, making it difficult to compare financial results

Basic Principles of Accounting

Measurement Revenue Recognition Expense Recognition Full Disclosure

Monetary Unit Assumption

Money is the common denominator of economic activity and provides appropriate basis for accounting measurement and analysis. It is relevant, simple, universally available, understandable, an useful. Ex: FASB in SFAC No. 5 indicates it expects the dollar to be used.

Verifiability

Occurs when independent measurers, using the the same methods, obtain similar results. Ex: two indepedent auditors count inventory and arrive at the same physical quantity.

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.

Assets

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

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.

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.

Revenue Recognition Principle

Revenue recognition generally occurs (1) when realized or realizable and (2) when earned.

Going Concern Assumption

The company will have a long life and continue to operate. Ex: Current & non current assets on balance sheet

Faithful Representation

The numbers and descriptions match what really happened. Info must be complete, neutral, and free of material error. Ex:

Industry Practices

The peculiar nature of some industries and business concerns sometimes requires departure from basic theory. Ex:public-utility companies report noncurrent assets first on the balance sheet to highlight the industry's capital-intensive nature. Agricultural companies often report crops at fair value because it is costly to develop accurate cost figures on individual crops.

Understandability

The quality of info that lets reasonably informed users see its significance. Ex: If GE issues a report but it is not understood by investors, it's useless.

Measurement Principle

Use either historic cost or fair value. Historic cost: companies report many assets / liabilities based on acquisition price. Fair Market: 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 Ex: F.S. not adjusted for inflation

Cost Constraint

Weighing the costs of providing information against the benefits that can be derived from using it.

Relevance

Accounting information must be capable of making a difference in a decision. Can be predictive, confirmatory, or both. Example: UPS changes past or present expectations based on previous evaluations.

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.

Full Disclosure Principle

Companies provide information that is of sufficient importance to influence the judgment and decisions of an informed user.

Expense Recongnition Principle

Companies recognize expenses when the work (service) or the product actually contributes to revenue.

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.

Distributions to Owners

Decreases in net assets of a particular enterprise result- ing from transferring assets, rendering services, or incurring liabilities by the enterprise to owners. Distributions to owners decrease ownership interests (or equity) in an enterprise.