Quiz 4

What are the three core financial statements? Briefly define the purpose of each statement (i.e. what is the gist of each statement). Indicate for each statement if it is for a point in time or a period of time. Hint: "The Statement of Cash Flows" and "The Footnotes" are NOT one of the three core financial statements!

1. balance sheet portrays the financial position of the company by showing what the company owns and what it owes at the report date. (point in time) 2. the income statement how a company performed during the period(s) presented and shows whether that company's operations have resulted in a profit or loss. 3. statement of changes in shareholders' equity reconciles the activity in the equity section of the balance sheet from period to period. Generally, changes in shareholders' equity result from company profits or losses, dividends and/or stock issuances.

Assets Examples

< 1 year Cash A/R Inventory Prepaid Expenses Non Current: PP&E Intangibles (patents)

Liabilities Examples

< 1 year A/P Income Tax payables LTL: deferred income taxes

Conservatism

A degree of professional skepticism should be adopted when assessing the prospects that incomplete transactions will be concluded successfully 1. When deciding between permissible accounting choices, some weight should be given to the one with lowest assets or highest liability Controversial: rejected by FASB as subjective and leading to deliberate misstatements and as such has "no place" in accounting. still observed by managers and others who believe that conservative accounting is both prudent and responsible.

Faithful representation

A perfectly faithful representation would be complete, neutral, and free from error. The objective is to optimize those qualities to the extent possible since perfection is difficult

Reliability of Evidence

Accountants recording events rely as much as possible on objective, verifiable documentary evidence.

Monetary Unit

Accounting is a measurement process that deals only with events that can be measured in monetary terms

Accounting Period

Accounting measures activities for a specific interval of time, called the accounting period.

Matching

Accounting profit is the net result of the matching of related costs and revenues of a period i. Matching "efforts and accomplishments" 1) Costs measure efforts and revenues measure accomplishments

Disclosure

Accounting reports should disclose enough info that they will not mislead careful readers who are reasonably well informed in financial matters

Materiality

Accounting standards only apply to significant items.

The "Dual Aspect" explains that every transaction affects at least two items in the basic accounting equation and preserves the equation's equality. What is the fundamental accounting equation?

Assets = Liabilities + Shareholders' Equity

CFFR

Conceptual Framework for Financial Reporting A framework that describes the objective of, and the concepts for, general purpose financial reporting;

Comparability

Current or past financial information about a reporting entity is more useful if it can be compared with similar information about other entities or the same entity in a different period.

Dual Aspect

Every transaction effects at least 2 items in the basic accounting equation and preserves the equation's equality i. Assets = Liability's + Stockholder's Equity

FASB

Financial Accounting Standards Board The private-sector organization in the United States that establishes financial accounting and reporting standards.

Relevance

Financial information is relevant if it would make a difference in the decisions of users because of its predictive or confirmatory value, or both.

Business Entity

Financial statement are prepared for a business entity that is separate and distinct from its owners

Revaluation Model

IFRS allows depreciable assets to be reported at their Fair value as long as it can be measured reliably

ICFR

Internal control over financial reporting (ICFR) Policies, procedures, and activities that help ensure that financial statements are presented in accordance with generally accepted accounting principles and faithfully represent the financial condition and results of operations of a reporting entity.

IASB

International Accounting Standards Board (IASB) The accounting standard- setting body outside the United States.

Historical Cost

Nonmonetary and monetary assets are ordinarily initially recorded at their acquisition price. This price, rather than current fair value, is the basis for subsequent accounting for nonmonetary assets.

Stockholder's Equity

Shows the amounts of funds owners have provided and, in parallel, their claims on the assets of a firm 1. Ownership interest in the entity 2. Excess of Total Assets over its Liabilities

Consistency

Similar transactions are reported in a consistent fashion. A. Once an entity has decided on one accounting method, it should use the same method for all subsequent events of the came character unless it has sound reason to change methods

SFAC

Statements of Financial Accounting Concepts (SFAC) A document issued by the FASB covering broad financial reporting concepts, providing a general overview of accounting concepts, definitions, and ideas.

US GAAP

The set of accounting standards issued by the FASB and followed by most US companies.

Purchasing power

The value of money expressed in terms of the amount of goods or services that can be purchased with it.

Companies must comply with certain rules and guidelines of either:

US GAAP (Generally Accepted Accounting Principles) IFRS (International Financial Reporting Standards)

Sarbanes-Oxley Act

US-based public companies must provide an assessment of internal control over financial reporting (ICFR) within their annual report

Going Concern

Unless evidence suggests otherwise, it is assumed that the entity will continue operations into the foreseeable future. For preparing + auditing financial statements, Assume that the entity will continue operations into the foreseeable future

1. For financial statements to be a perfectly faithful representation, a depiction would have three characteristics.

a. It would be complete b. neutral c. free from error

Main argument for using historical Method

d. Desire for objective, reliable evidence is main argument for using the historical cost method

Assets

economic resources that have probably future, economic benefits to a firm

"net sales"

item includes the amount reported after taking into consideration returned goods and allowances for price reductions or discounts.

Liabilities

probable future sacrifices of measurable economic benefits arising from the entity's obligation to convey assets to or perform services for a person, firm or another organization creditors' claims for funds, usually because they have provided funds, or goods and services, to the firm

Cash Basis of Accounting

recognizes revenues when cash is received, and expenses when they are paid. does not recognize A/R or A/P

Accrual Method

revenues and expenses are recorded when they are earned, regardless of when the money is actually received or paid (-)doesn't provide any awareness of cash flow; (+)gives a more realistic idea of income and expenses during a period of time a transaction is recognized on the income statement when the earnings process is completed, that is, when the goods and/or services have been delivered or performed or an expense has been incurred.

neutral depiction

without bias in the selection or presentation of financial information

Most annual reports have three sections:

• 1. The Letter to Shareholders gives a broad overview of the company's business and financial performance. • 2. The Business Review summarizes a company's recent developments, trends and objectives. • 3. The Financial Review presents a company's business performance in dollar terms and consists of the

Asset can represent future economic benefit in 4 ways

1. Asset may be used to acquire other assets (Ex. Cash) 2. Asset represents a claim to another entity for money (Ex: A/R -> amount company is owed due to credit sales) 3. Assets can be converted to cash or money claim (Ex: Finished goods inventories when sold) 4. Asset has potential benefits, rights or services, allowing the entity to earn something from its use (Ex: Raw Materials)

List 12 Basic Accounting Concepts

1. Business Entity 2. Going Concern 3. Monetary Unit 4. Historical Cost 5. Accounting Period 6. Consistency 7. Matching 8. Dual Aspect 9. Reliability of Evidence 10. Disclosure 11. Materiality 12. Conservatism

The article discusses 12 basic accounting concepts and assumptions that anyone interested in financial statements need to understand. Excluding the "Dual Aspect", list FOUR of the other 11 and describe in a sentence or two. If you forgot the answer to Question #1 (Dual Aspect), you can list two additional concepts (6 total) for two potential bonus point

1. Business Entity Financial statement are prepared for a business entity that is separate and distinct from its owners 2. Going Concern Unless evidence suggests otherwise, it is assumed that the entity will continue operations into the foreseeable future. 3. Accounting Period Accounting measures activities for a specific interval of time, called the accounting period. b. Financial statement must indicate the period covered 4. Matching Accounting profit is the net result of the matching of related costs and revenues of a period i. Matching "efforts and accomplishments" ii. accomplished via accrual accounting

Shareholders' Equity Examples

1. Capital stock represents shares in the ownership of the company. 2. Preferred stock is an equity ownership interest that has preference over common shares with regard to dividends and the distribution of assets in case of liquidation. 3. Common stock has no such limit on dividends payable each year. 4. Additional paid-in capital is the amount paid by shareholders in excess of the par or stated value of each share. 5. Retained earnings are the accumulated profits the company earns and reinvests or "retains" in the company

Cash flows are also separated by 3 business activities

1. Financing activities include those activities relating to the receipt and repayment of funds provided by creditors and investor 2. Investing activities include those activities relating to asset acquisition or disposal. 3. Operating activities basically include all activities not classified as either financing or investing activities.