mgmt 160 quiz 4

Reliability of Evidence

*Accountants recording events rely as much as possible on objective, verifiable documentary evidence instead of subjective and potentially biased judgements of a person* Accountants recording events rely as much as possible on objective, verifiable documentary evidence instead of on the subjective and potentially biased judgments of a person. Acceptable evidence includes source documentation (both paper and digital) of such items as: •Sales invoices •Purchase (supplier) invoices •Checks written and received •Payment vouchers •Bank statements •Receiving reports •Time cards and payroll journals •Credit memos

Monetary Unit

*Accounting is a measurement process that deals only with events that can be measured in monetary terms.* - reflects the fact that money is the common denominator used in business to measure the exchange value of goods, services, and capital. - Obviously, financial statements should indicate the currency on which they are based.

Accounting Period

*Accounting measures activities for a specific interval of time, called the accounting period.* = purposes, managers and investors need periodic "test readings" of the progress of the business. Accounting recognizes this, breaking the flow of business activity into a series of reporting periods or fiscal years that are usually 12 months in length. - Regardless of the length of the period, the financial statements must indicate the period covered.

Matching

*Accounting profit is the net result of matching related costs and revenues.* = *The income or profit reported on a financial statement is the net result of the matching of related costs and revenues of a period* = *This process can be described as matching "effort and accomplishments"—costs measure effort, and revenues measure the related accomplishments* - But the process can become complicated, because costs often cannot be easily matched with specific current or anticipated revenues. - Matching costs and revenues may require deferring recognition of expenses and revenues to future periods. *The matching process is usually achieved through application of the accrual method of accounting rather than the cash method. *

Disclosure

*Accounting reports should disclose enough information that they will not mislead careful readers reasonably well informed in financial matters.*

Materiality

*Accounting standards apply only to material items.* = Accounting standards apply only to material items. Inconsequential items can be dealt with expediently. - Whether or not an item is immaterial is a matter of judgment. - One common test of materiality is whether the decision of a reasonably well informed reader of financial statements would be altered if the item were treated differently. **If the decision would change, then the item is material.-matter of judgement

Conservatism

*Conservatism: A degree of professional skepticism should be adopted when assessing the prospects that incomplete transactions will be concluded successfully. Although conservatism has been rejected by the FASB and IASB as an "official" accounting concept, it is often observed by managers and others who believe that conservative accounting is both prudent and responsible.* The conservatism concept is controversial. - In practice, this means that in deciding between permissible accounting choices, some added weight should be given to whichever choice leads to the lowest asset or highest liability figures. - also means that more-stringent requirements should be imposed for recognizing revenues and gains as components of earning than for recognizing expenses and losses. The FASB rejects conservatism as a legitimate accounting concept. In the opinion of the FASB, the concept leads to deliberate misstatements and as such has no place in accounting.

Dual Aspect

*Every transaction affects at least two items in the basic accounting equation.* = the concept that every transaction affects at least two items in the basic accounting equation and preserves the equation's equality. The fundamental accounting equation: Assets = Liabilities + Stockholders' equity Accounting systems are designed to record events in terms of their influence on at least two of the following categories: assets, liabilities, and owners' equity.

Business Entity

*Financial statements are prepared for a business entity that is separate and distinct from its owners.* = defines the accountant's area of interest: a business entity that is separate and distinct from its owners. - sets limits on the possible objectives and contents of financial reports. - The accountant's role is to prepare financial statements for the business entity—the affairs of the owners are irrelevant to those statements. - easy for larger companies than smaller companies to tease out the business entity's assets and liabilities

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. Most monetary assets are accounted for at fair value following their acquisition. IFRS permits some nonmonetary assets to be accounted for at fair value following acquisition.* = For accounting purposes, business transactions are measured initially in terms of their actual (historical) cost, a value that is usually easily documented by reliable sources such as contracts, invoices, and other readily available sources. - This basic accounting concept applies not only to the initial recording but also in many cases to the subsequent reporting of transactions. - financial statements are said to conform to the "mixed attributes" accounting model. That is, some balances, such as property, plant, and equipment, are reported under US GAAP on a historical cost basis while others, such as marketable securities held for trading purposes, are reported on some measure of current value. - It is important that financial statement users learn when and which accounts are stated at their historical cost or at current value. - In the case of monetary assets, accounting is more likely to report them periodically at some measure of their current value.

Consistency

*Similar transactions are reported in a consistent fashion.* = The consistency concept *states that once an entity has decided on one accounting method, it should use the same method for all subsequent events of the same character unless it has a sound reason to change methods* - Accountants place considerable emphasis on consistency because it improves the reliability of the information reported to external parties. - Consistency does not necessarily require uniformity of accounting practices among affiliated business units or even within a unit or company.

Going Concern

*Unless evidence suggests otherwise, it is assumed that the entity will continue operations into the foreseeable future.* = those preparing and auditing general purpose financial statements for a business entity assume that the entity will continue operations into the foreseeable future. = The going concern assumption reflects management's and investors' normal expectation about the life of a business. *statements, the financial statements of business entities with limited lives must clearly indicate the terminal date and type of liquidation involved. Otherwise, the reader will assume that the accounts are based on the presumption that the enterprise has an indefinitely long life.

income statement (summary)

-period of time -results of the operating activities of a firm for a specific time period -net income=revenues-expenses

statement of cash flows (summary)

-period of time -shows where the firm obtains or generates cash and where it spends or uses cash -reports info about cash generated from or used by -operating, investing, financing activities during specific time periods

balance sheet (summary)

-point in time -snapshot of the investing and financing activities at a moment in time

the statement of changes in shareholders' equity (not a core statement**)

-reconciles the activity in the equity section of the balance sheet from period to period -changes in shareholders' equity result from company profits or loss, dividends and/or stock issuances

the statement of cash flow

-reports on the company's cash movements during the *period(s)* separating them by operating, investing and financing activities -presents the changes in cash resulting from business activities -cash flow analysis is necessary to make proper investing decisions and to maintain operations

the income statement

-the "motion picture" -reports on how a company performed during the *period* (s) presented and shows whether the company's operations have resulted in a profit or loss *shows how much the corporation earned or lost during the year* -more important to investors -shows the record of a company's operating results for the whole year -serves as a valuable guide in anticipating how the company may do in the future

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

components of an annual report

1) 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 "Management's Discussion and Analysis" and "audited financial statements"

SFAC No. 8 defines 7 requirements:

1) 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. 2) Faithful representation: = To be useful, financial information must faithfully represent the phenomena it purports to represent. A perfectly faithful representation would be complete, neutral, and free from error. While this may be difficult to adopt in practice, the objective is to optimize those qualities to the extent possible. 3) Materiality: = Information that is immaterial is not useful. Immaterial information is information that would not influence the decisions of financial statement users. 4) 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. 5) Verifiability: = Verifiability means that knowledgeable and independent individuals would reach a consensus that a particular representation is measurably faithful. 6) Timeliness: = The financial statement information should be available to financial statement users in time to influence their decisions. 7) Understandability: = According to SFAC No. 8, the boards believe classifying, characterizing, and presenting information clearly and concisely makes it understandable.

Limitation of the monetary unit concept

1) accounting—its inability to record or communicate factors such as the state of the company president's health, the attitude of the labor force, or the relative advantage of competitive products. - Consequently, the most important aspects of a business may not be reflected in the financial statements. 2) it fails to distinguish between the purchasing power of monetary units in different periods. This can become a significant problem in trying to interpret financial statements during periods of high inflation.

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 Changes in Shareholders Equity" and "The Footnotes" are NOT one fo the three core financial statements.

1) the balance sheet (point in time) 2) the income statement (period of time) 3)the statement of cash flows (period of time) *indicate if they are for point in time or period in time*

Statement of Financial Accounting Concepts No. 8 (SFAC No. 8).

= It sets forth their (the FASB and IASB) views on the qualitative characteristics of financial information that is most useful to existing and potential investors, lenders, and other creditors for making decisions about the reporting entity.

Define the basic accounting concepts and assumptions

= are the framework upon which financial reporting in general is based.

According to the FASB, what is the objective of general purpose financial reporting?

= it is 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. - Those decisions involve buying, selling, or holding equity and debt investments and making or settling loans and other forms of credit. *they provide information to help existing and potential investors, lenders, and other creditors to estimate the value of the reporting entity.

The cash method of accounting

= records cash receipts and disbursements and focuses on changes in the cash account. *recognizes revenues when cash is received and expenses are paid* does not recognize accounts receivable or accounts payable, many small business opt to use the cash basis of accounting because it is simple to maintain. beneficial=in terms of tracking how much cash the business actually has at any given time, income also isn't taxed until it's in the bank

The accrual method of accounting

= seeks to measure changes in the owners' equity during the accounting period. *revenues and expenses are recorded when they are earned, regardless of when the money is actually received or paid* more commonly used than cash method, *upside* =gives a more realistic idea of income and expenses during a period of time-provides long term picture of a business that cash accounting can't provide, *downside*=doesn't provide any awareness of cash flow-business can appear profitable while in reality it has empty bank accounts

What does the US GAAP (US generally accepted accounting principles) do?

Accounting principles provide guidance on accounting policy decisions for a specific transaction or event; the basic concepts are the broader framework that defines both the value and the limitations of financial statements.

an important use of financial analysis

An important use of financial analysis is to identify approaching financial difficulties and possible bankruptcy on the basis of data contained in a company's most recent financial statements, which may have been based on the assumption that the entity was a going concern.

The fundamental accounting equation:

Assets = Liabilities + Stockholders' equity

Assets

Assets represent probable future, measurable economic benefits that the reporting entity has acquired through a transaction. - Assets include such items as cash, inventories, and buildings. can represent an expected future economic benefit: 1 The asset may be used to acquire other assets. 2 The asset represents a claim on another entity for money 3 The asset can be converted to cash or a money claim. 4 The asset has potential benefits, rights, or services, allowing the entity to earn something from its use.

Liabilities

Liabilities are probable future sacrifices of measurable economic benefits arising from the entity's obligations to convey assets to or perform services for a person, firm, or another organization. - Accounts payable to trade creditors, bonds payable, and taxes payable are examples of liabilities.

one purpose of financial analysis

One of the purposes of financial analysis is to determine whether the basic accounting concepts reflected in a particular company's financial statements are reasonable representations of the company's circumstances.

Stockholders' or owners' equity

Stockholders' or owners' equity represents the ownership interest in the entity. - It is the excess of the entity's total assets over its total liabilities.

Why does the FASB reject conservatism?

The FASB rejects conservatism as a legitimate accounting concept. 1) In the opinion of the FASB, the concept leads to deliberate misstatements and as such has no place in accounting. 2) The FASB believes that statement issuers should provide unbiased data so that statement users can evaluate the risk of, say, investing in the reporting company. 3) If conservatism is applied, the FASB believes issuers allow their evaluations of risk to substitute for the user's independent evaluation, which might have been different if unbiased data had been available.

conservatism (summary)

a degree of professional skepticism should be adopted when assessing the prospects that incomplete transactions will be concluded successfully.

audit

a systematic examination of a company's financial statements

The difference between revenues and expenses:

a) Revenues are realized from noncapital transactions that result in an increase in the owners' equity. b) In contrast, expenses are expired costs that are associated with the period, or with revenues during the period that decrease owners' equity. = The difference between revenues and expenses is the net income for the period. - These changes in the owners' equity may not result in changes in the cash account.

reliability of evidence (summary)

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

monetary unit (summary)

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

accounting period (summary)

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

matching (summary)

accounting profit is the net result of matching related costs and revenues

disclosure (summary)

accounting reports should disclose enough information that they will not mislead careful readers reasonably well informed in financial matters

materiality (summary)

accounting standards apply only to significant terms

the balance sheet

also called "statement of financial position" -portrays the financial position of the company by showing what the company owns and what it owes at the report date -reports the company's financial position at a specific *point in time* -represent the current period and a previous period so that financial statement readers can easily identify significant changes *divided into two halves*: assets and liabilities and shareholders' equity, assets=liabilities+shareholders' equity assets=all goods and property owned by the company and uncollected amounts due (receivables) to the company from others liabilities=all debts and amounts owed (payables) to outside parties and lenders shareholders' equity=the shareholders' ownership interest in the company (what the company's assets would be worth after all claims upon those assets were paid)

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+stockholders' equity

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 points. You can only get the bonus points if you received no points on Question #1.

business entity, going concern, monetary unit, historical cost, accounting period, consistency, matching, dual aspect, reliability of evidence, disclosure, materiality, conservatism

2 methods of accounting

cash method of accounting accrual method of accounting

dual aspect (summary)

every transaction affects at least two items in the basic accounting equation

Business Entity (summary)

financial statements are prepared for a business entity that is separate and distinct from its owners

What does it mean to conform to the "mixed attributes" accounting model?

financial statements are said to conform to the "mixed attributes" accounting model. = That is, some balances, such as property, plant, and equipment, are reported under US GAAP on a historical cost basis while others, such as marketable securities held for trading purposes, are reported on some measure of current value. - It is important that financial statement users learn when and which accounts are stated at their historical cost or at current value.

historical cost (summary)

non-monetary and monetary assets are ordinarily initially recorded at their acquisition price.

the footnotes (not a core statement**)

provide more detailed information about the financial statements

consistency (summary)

similar transactions are reported in a consistent fashion

What do the Financial Accounting Standards Board (FASB) in the United States and the International Accounting Standards Board (IASB) do?

they give preparers of financial statements a shared foundation for the reporting of data; and they help users fully appreciate the information that financial statements convey.

going concern (summary)

unless evidence suggests otherwise, it is assumed that the entity will continue operations into the foreseeable future