EXAM 1 (Doyle)

When you spend cash you have two options.

Capitalize (a deferral) - Put supplies as an asset, then expense it when it's used. Expenditure (Expense it right away)

Comprehensive Income:

Changes in equity from non owner sources Net income + or - OCI = Comprehensive Income

Why do we do closing entries?

Closing entries are necessary because we want to "start over" with the measurement of performance each accounting period. We reset the income statement accounts to zero and start measuring performance (net income) over again each period. "What have you done for me lately?"

Disclosure Dominion:

Companies can disclose stuff but they can't intend to deceive. That would make them go in to fraud land.

Main benefit of rules and standards?

Comparability --> Decision usefulness

What are the 4 enhancing characteristics?

Comparability, Timeliness, Understandability, Verifiability

What is comprehensive income?

Comprehensive income is the change in equity during a period from ALL sources EXCEPT contributions from and distributions to owners

Is convergence still happening?

Convergence is still happening... "We're trying to make things similar then we try to, but not exactly issuing joint standards anymore."

What was FASB's first project?

Create conceptual framework.

When you close out revenues, you _____________ retained earnings?

Credit (+SE)

Closing Expenses?

Credit Expenses Debit Retained Earnings

Revenue Recognition:

Current: 1. Earned 2. Realized or Realizable New: Satisfy performance obligation

When you close out expenses, you ____________ retained earnings?

Debit (-SE)

Closing Revenues?

Debit Revenues Credit Retained Earnings

Overall objective of financial reporting is ____________________ NOT _______________________________.

Decision usefulness, NOT maximizing profitability.

ON a cash basis vs an accrual, over the lifetime of a company the result is ______-

the same.

What are the qualitative characterstics?

"Qualitative characteristics of accounting information" are those characteristics which contribute to the quality or value of the information. The overriding qualitative characteristic of accounting information is usefulness for decision making. These qualitative characteristics are what make information "good" and help FASB decide which economic information should be recognized and also disclosed in the footnotes.

What is convergence?

"let's make the rules the same for everyone all over the world."

To close out an expense....?

(-E) and (-SE)

What is the label for sales discounts? (specifically to close them out)

(-XR)

Why is a conceptual framework necessary?

(a) It will enable the FASB to issue more useful and consistent standards in the future. (b) New issues will be more quickly solvable by reference to an existing framework of basic theory. (c) It will increase financial statement users' understanding of and confidence in financial reporting. (d) It will enhance comparability among companies' financial statements.

Double Entry Accounting:

1 transaction, 2 sides to the coin

Foggy Crystal Ball? (in regards to why accruals go bad)

1) accrual accounting involves estimates (crystal ball needed) 2) the future is uncertain so there are errors in the estimates (there is fog in the crystal ball) 3) these unintentional errors tend to be symmetrically distributed around the original estimate (noise). *NOISE

Evil Managers? (in regards to why accruals go bad)

1) accrual accounting involves estimates and managers have discretion in making these estimates 2) managers have incentives to prefer aggressive income (e.g., higher net income) 3) managers sometimes intentionally manipulate the accruals causing errors that are biased. *BIASED

Representationally Faithful:

1. Complete 2. Neutral 3. Free From Error Information that is highly representationally faithful would be measurements of the heights of basketball players on a team. Information about how "handsome" or "beautiful" the players are would not be very representationally faithful. The measurement would be very subjective as "beauty is in the eye of the beholder."

Characteristics of an Auditor: (solution of problem of lemons)

1. Independent 2. Competent

Relevant:

1. Predictive Value 2. Confirmatory Value 3. Materiality For example, if we are trying to decide who to hire as our basketball coach, relevant information would include the candidate's previous coaching record. Irrelevant information would include the candidate's favorite food or their favorite color.

Liability:

1. Probable Sacrifies of future economic benefits 2. Obligation that is present 3. Result from past transaction

Asset:

1. Probable future economic benefits 2. Controlled 3. Must result from a past transaction

Problem of the Lemons

1.) Information Asymmetry 2.) Incentives to withhold information. Everyone is worse off... market breakdown

Change in Accounting Principle/Method:

1.) Prior period adjustment ONLY in prior periods. 2.) Restate any prior periods being presented in current year.

Forms of the SEC

10 K (1 per year) 10 Q (Quarterly) 8 K (Disclosure if market will respond)

ASU

Accounting Standards Update (ammendment to the rules) *2015-01 (means it was the first ASU of the year)

ONLY the _________ form is required to be audited?

10- K

SOX: (When? Why? What?)

2002 Because of Enron and such. 1. PCAOB - Audit the auditors 2. Audit of internal controls (section 404) 3. CFO and Partner sign off 4. Partner must rotate 5. No non-audit fees (can do tax and audit, but not audit and consulting) 6. Increased Penalties

If there are more than ________ fasb members talking it is considered a public meeting.

3

What is the conceptual framework?

A conceptual framework is a coherent system of interrelated objectives and fundamentals that can lead to consistent standards and that prescribes the nature, function, and limits of financial accounting and financial statements.

How do adjusting entries relate to the periodicity assumption?

Adjusting entries are necessary because financial statements impose artificial cutoffs (periodicity), making accrual-based measurement at that cutoff point necessary. For example, a 12/31/04 year-end requires that all revenues and expenses for the artificial year 1/1/04 to 12/31/04 be properly recognized in that accounting period.

Why are adjusting entries made? (what two conceptual framework ideas to they pertain to)

Adjusting entries update the accounts to make sure all revenues earned and expenses incurred are recognized in the proper period in the financial statements *Periodicity and Timeliness

What is a closing entry?

All Revenue and Expense (temporary) accounts are closed at the end of the accounting period to Retained Earnings (for a corporation).

Purpose of Adjusting Journal Entries?

Allocate revenues and expenses to their proper periods using the revenue and expense recognition principles

What is an adjusting entry?

An adjusting entry is made to allocate revenues (based on the revenue recognition principle) and expenses (based on when the expenses are incurred) in a given period on an accrual basis.

Going Concern

Assume company is infinite. If you have substantial doubt, you must apply liquidity accounting. Rationale why plant assets are not reported at liquidation value

Monetary Unit

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

What is an example of a deferral?

CASH first RECOGNITION second Unearned Revenue Inventory Prepaids Depcreciation Expense (prepaid building)

What are the two smaller committees on the FASB?

EITF: Emerging Issues Task Force PCC: Private Company Council

Accounting Cycle:

Economic Information Recognize? (decision usefulness) Journal Entry Ledger Trial Balance Adjusting Entries Closing Entries Financial Statements

EITF:

Emerging Issues Task Force: Smaller Technical Issues, cannot amend the codification by themselves, still has to be passed by the FASB. Usually will say in consensus with the EITF.

Full Disclosure

Ensures that all relevant financial information is reported.

Capital Allocation Model?

Entrepreneures --> Ideas to investors --> Investors give money to entrepreneurs.

SEC delegates authority to:

FASB

What are the two main reasons accruals "go bad" or don't turn into cashflows?

Foggy Crystal Ball Evil Manager

What is a deferral?

For a deferral (a prepayment), the cash is received or paid first, and the accounting recognition of a revenue or expense is deferred until it is actually earned or incurred. The deferred accounting recognition shows up as a liability for revenue (unearned revenue) or as an asset for an expense (prepaid expense or some other asset). Revenues: Unearned Revenues Expenses: Prepaids

What is an accrual?

For an accrual, the accounting recognition of a revenue or expense comes 1st, and the cash is received or paid later. The accrued revenue is usually recognized as some kind of receivable asset, and the accrued expense is usually recognized as some kind of payable liability. *Also note that both deferrals and accruals are often referred to as "accruals" in general, as in "accrual accounting." Revenues: Accounts Receivable Expenses: Accounts payable

SEC:

Formed because of the 1933 and 1934 securities act, which happened because of the great depression, people wanted more control and protection from the government.

What are the four assumptions?

Going Concern, Monetary Unit, Economic Entity, Periodicity.

What are the two fundamental qualities of useful information?

Relevant, Representation Faithfulness

___________________ is usually more important to investors.

Income Statement

To show Earnings per share on the balance sheet where do you start the calculation if there are discontinued operations?

Income from continuing operations - Loss From Discontinued operations (net of tax) ------------------------------------------------------- Net Income

Economic Entity

Indicates that personal and business record keeping should be separately maintained and that there should be combined financial statements for big co and little co, back out the piece they don't own.

Revenues:

Inflows of assets in a period that come from providing a service or delivering a good. Includes gains... sold a truck and got more... etc.

Expense Recognition

Records expenses as net assets are used up in order to produce revenue

Comparability:

Information that is measured and reported in a similar manner for different companies is considered comparable. Comparability enables users to iden- tify the real similarities and differences in economic events between companies. For (in millions) (in billions) example, historically the accounting for pensions in Japan differed from that in the United States. In Japan, companies generally recorded little or no charge to income for these costs. U.S. companies recorded pension cost as incurred. As a result, it is difficult to compare and evaluate the financial results of Toyota or Honda to General Motors or Ford. Investors can only make valid evaluations if comparable information is available.

Examples of internal control:

Internal auditor, Double Checking, Sox, Audit of audit. Separation of duties... etc.

Expenses:

Losses... outflow (using of) net assets in order to produce a revenue.

Measurement Principle

MIXED ATRIBUTE SYSTEM: We have a mixed system and we measures things differently, historical cost and fair value.

What does the problem of the lemons cause?

Market Breakdown, people don't trust and everyone is worse off.

What are the basic principles?

Measurement, Expense recognition, Revenue Recognition, and Full Disclosure

An adjusting journal entry....

NEVER INVOLVES CASH

Change in prospective adjustment:

NO PRIOR PERIOD ADJUSTMENTS: Don't go fix it and restate it because it happens way too often. (these are the Errors that create noise). Example: You decide that your equipment actually has a useful life of 20 years instead of 10) Take the book value of the machine and divide it by the rest of its useful life. And then depreciate from that amount.

Do you close out accumulated depreciation?

NO, Never

To Get Earnings per share?

Net Income - Preferred Dividends Paid Out ------------------------------------------------ Common Shares Outstanding

If information is recognized it is...

On the financial statements

PCC:

Private Company Council, Exceptions for smaller companies.

PCAOB:

Public Company Accounting Oversight Board -They create auditing standards and audit the auditors

What is an example of an accrual?

RECOGNITION first CASH 2nd Accounts receivable Accounts payable

Understandability:

Reasonable person with basic understanding should be able to interpret. Understandability is enhanced when information is classified, characterized, and presented clearly and concisely.

Equity:

Residual, left over Represents owner interest Capital Stock and Retained Earnings

Codification?

Restructuring of GAAP, FAS 168

What types of accounts do you close out?

Revenues, and Expenses

Evolution of FASB:

SEC --> AICPA -->APB (too broad, didn't get anything done) --> FASB (7 people)

How are errors treated?

Same as change in accounting principle/method.

Periodicity

Separates financial information into time periods for reporting purposes.

Conceptual Framework:

Serves as the principles, non authoritative isn't technically part of GAAP.

What is the all inclusive principle?

The "all-inclusive" income concept requires that all items that affect equity (other than owner distributions/contributions) should go through the income statement. Under the "all-inclusive" income concept, comprehensive income would be equal to net income. However, since some items that affect equity do not go through the income statement, the "all-inclusive" concept is violated for "net income".

Cost Constraint:

The benefits must outweigh the costs. Cost to prepare, cost to read and understand, NOT economic consequences.

How are dividends closed out?

You debit Retained Earnings.

What are the benefits of providing accounting information?

The benefits of providing accounting information are experienced by society in general, since informed financial decisions help allocate scarce resources to the most effective enterprises. This will reduce "information risk" and reduce the cost of capital in the economy. These benefits also help individual investors, who can make better investment decisions. It will be easier to assess managerial performance (the stewardship role of accounting) and better able to predict the future of companies (e.g., analysts who predict future earnings will be more accurate).

What are the costs of an accounting system?

The costs of providing accounting information are paid primarily to highly trained accountants who design and implement information systems, retrieve and analyze large amounts of data, prepare financial statements in accordance with authoritative pronouncements, and (internally) audit the information presented. These activities are time-consuming and costly. There are costs to provide external audits (paid by the companies). There can be costs to users and investors if the information is too complex, too noisy, or insufficient. If poor information is provided, investors don't feel as confident in their investments and demand a higher return due to the higher risk (i.e., a higher cost of capital for the firm).

What is the difference between a deferral and an accrual?

The main difference is the timing of the cash flows and the accounting recognition.

What is the primary objective of financial reporting?

The primary objective of financial reporting is to provide information that is useful in investment and credit decisions for individuals who have a reasonable understanding of business

What is the purpose of a trial balance?

The trial balance analyzes the need for adjusting entries, NOT closing entries. It is a list of closing balances of ledger accounts on a certain date and is the first step towards the preparation of financial statements. It is usually prepared at the end of an accounting period to assist in the drafting of financial statements.

How is it done?

This means that a debit or credit is made to each Revenue and Expense account in order to bring the ending balance in these accounts to zero. It is also possible to close each Revenue and Expense account to Income Summary first, and then to Retained Earnings. Note that Gain and Loss accounts are also closed.

What conceptual framework elements deal with adjusting journal entries?

Timeliness, Periodicity, Expense Recognition, Revenue Recognition

Principle of Closing entries?

What have you done for me lately?

GAAP Evolution:

When they started having rules that everyone had to follow, used the rules that the majority of companies were using. Over time there was dissatisfaction with the traditions that had persisted. APB was formed Difference between CAP (Cpa's) and APB (more broad board) They argued about what they could do to make better standards... so they created the FASB (1973) Less people (broad people) Conceptual framework (need for a constitution)

Current Assets:

Within a year... ordered by liquidity.

Timeliness:

means having information available to decision-makers before it loses its capacity to influence decisions. Having relevant information available sooner can enhance its capacity to influence decisions. A lack of timeliness, on the other hand, can rob information of its usefulness. For example, if Dell waited to report its interim results until nine months after the period, the information would be much less useful for decision-making purposes.

Verifiability:

occurs when independent measurers, using the same meth- ods, obtain similar results. Verifiability occurs in the following situations.

Balance sheet is more _______ ________ and ______________-

short term and fundamental