Accounting Exam 1 Complete Review

Know what EPS, what does sit measure and where is it presented on the income statement.

Earnings per share represents the amount of earnings assigned to each outstanding share of the company's common stock. They are reported for continuing operations, discontinued operations, and net income.

Earnings Quality

Earnings quality captures the degree to which reported income provides financial statement users with useful information for predicting future firm performance. There are two factors impacting earnings quality: 1. It is dependent upon whether the components of earnings presented are permanent or transitory in nature. 2. Management will sometimes engage in earnings management by using the discretion afforded under the accounting standards to manipulate earnings to meet desired goals.

What are the ways in which the income statement can be useful?

Evaluate past performance, Predict future performance, and/or Assess risks or uncertainties of achieving future cash flows

What are some limitations of the income statements?

Exclude certain items, Depend on accounting methods, Require extensive judgment and estimation

What are the qualitative characteristics of financial reporting?

Fundamental characteristics and enhancing characteristics

Under what circumstances is the going concern assumption not followed?

If the company is jeopardy of failing (e.g. bankruptcy), then the going concern assumption would not be valid. Accountants would measure assets and liabilities at the amount at which they expect to dispose of them, liquidation values.

6. What is the going concern assumption Chapter 2.

Indicates that accountants will record transactions and prepare financial statements as if the entity will continue to operate for an indefinite period of time, unless there is evidence to the contrary -justifies ST/LT classifications on balance sheet and depreciation of buildings for as long as 40 years -tied to the use of historical cost -market values are less relevant

What is net income?

Is a measure of financial performance resulting from the aggregation of revenues, expense, and losses that are not items of other comprehensive income

What are the primary elements of the income statement?

It includes four primary elements: revenues, expenses, gains, and losses. Managers make decisions regarding the presentation, format, and the elements to include in the income statement.

What are some limitations of such financial statements?

It is considered general purpose; however, most financial information is provided to satisfy users with limited ability to obtain additional, such as investors and creditors.

5. What is the conceptual framework? Chapter2

It sets forth theory, concepts and principles to ensure that accounting standards are coherent and uniform -intended to assist standard setters in developing and revising accounting standards. But it does not override accounting standards.

What is materiality? 2-6

Reporting it inaccurately or omitting it would affect FS user's decisions -level of materiality can depend on size or nature -$5ooo computer loss material for a small company but not big company -the planned disposition of a major operating segment is material by nature

What are general purpose financial statements?

The general purpose financial statements are: balance sheet, comprehensive income, cash flows, and shareholders' equity. They are called general-purpose because they provide information to a wide spectrum of user groups: investors, creditors, financial analysts, customers, employees, competitors, suppliers, unions, and government agencies.

What are the key differences between IFRS and GAAP?

The greatest difference between the two standards is that U.S GAAP contains many more rules than does IFRS. Both base standards on their respective conceptual frameworks.

What is the nature approach?

The nature approach refers to classification by the source of the expense such as: payroll costs, cost of raw material, or depreciation expense.

equity

The net assets (difference between asses and liabilities) - amount is cumulative result of investment by owners, comprehensive income, and distribution owners

What is their purpose and focus of GAPP and IFRS?

The purpose is to create a standards and rules that companies follow to help individuals compare companies

verifiability

a group of reasonably informed FS users are able to reach a consensus decision that reported information is a faithful representation of an underlying economic event i.e. accountants agree a company owes $100,000

comparability

allows FS users to identify and understand similarities and differences among several entities i.e. can compare between companies and from year to year

What is professional skepticism?

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

What are Permanent Items

are likely to continue in the future. For example, earnings from sales revenue, costs of goods sold, selling expenses, general and administrative expenses, interest expense.

What are Transitory Items

are unlikely to continue in the future. For example, gains or losses from the sale of equipment, impairment losses, other unusual or infrequent items, and discontinued operations.

Deferred expenses

are when company makes a cash payment before incurring an expense. For example, paying rent in advance, Prepaid rent.

overconfidence bias

being more confident than your abilities and experience level would objectively warrant

financial capital maintenance

capital is viewed as the financial amount, or money amount, invested in a company -company earns profit only if the financial amount of the equity is greater at the end of the period than it was at the beginning

physical capital maintenance

capital is viewed as the productive capacity of a company, such as units of output per day-a company earns profits if its productive capacity is greater at the end of the period than it was at the beginning

The single-step income statement

combines all revenues and gains, and all expenses and losses into single categories. There are several drawbacks to it: 1. It combines revenues and gains and expenses and losses without classification. 2. It does not separate operating and non-operating items. 3. It does not classify expenses by function, such as selling expenses and general and administrative expenses. 4. It doesn't identify key performance measures.

Exclude certain items

companies cannot measure certain revenues, expenses, gains, and losses reliably; therefore, they do not report them on the income statement. Unreliable information would result in financial statements that lack faithful representation. i.e. Upcoming lawsuits

losses

decreases in equity (net assets) from all other transactions and events except those that result from expenses or distribution by owners

distributions to owners

decreases in equity of a particular business enterprise resulting from transferring assets, rendering services, or incurring liabilities by the enterprise owners

Require extensive judgment and estimation

due to significant subjectivity and estimation uncertainties involved in financial reporting, management can bias their judgments to enhance the entity's financial performance by manipulating revenues, gains, expenses, and losses.

9. What is the information discussed regarding judgements used in the preparation of the financial statements?

elements of judgement 1) should a business even be recorded/when (when to recognize revenue) 2) what is the appropriate financial reporting treatment 3) what amount should the company report in the financial statements related to the business event (inventory) **flexibility is afforded in the selection and application of accounting standards (FIFO v. LIFO)

anchoring bias

focusing on one piece of information (often the first piece of data encountered), weighting it more heavily than other pieces of information

neutral

free from bias in both the selection process and presentation of financial data i.e. cannot omit data that is unfavorable -discloses information only about the lawsuit where it expects to have a favorable outcome (not all 3)

revenue recognition principal 2-11

in conceptual framework, a company should recognize revenue when it is realized or realizable and earned 1) when a company exchanges G&S for cash and cash claims 2) when a seller has accomplished what it must do to be entitled to the revenues

Complete

includes all information - both descriptions and explanations - necessary for the FS user to understand the underlying economic event -listing description of the nature of assets, balance by type, and accounting method used instead of just "long-lived assets"

Evaluate past performance

income statements enable users to evaluate the entity's past performance. It also provides confirmatory value, which is an aspect of relevant information.

gains

increases in equity (net assets) from an entity's peripheral or incidental transactions and all other transactions 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 obtained or increase ownership interests

What is faithful representation (3)

indicates whether financial information depicts the substance of an economic event in a manner that is 1) complete 2) neutral 3) free of error

revenues

inflows or other enhancements of an entity's assets or settlements of its liabilities from delivering or producing G&S that constituted the entity's ongoing central operations

Relevance (3)

info is capable of making a difference in decision making by exhibiting: 1) Predictive value 2) confirmatory value 3) materiality

timeliness

information is available early enough to make a difference in decision making

understandability

information is understandable to reasonably informed FS users when FS classify, characterize,and clearly present all info

Depend on accounting methods selected

like using different depreciation methods will report a different net income, resulting in reduced comparability

expenses

outflows or other consumption of assets or incurences of liabilities from delivering or producing G&S that constituted the entity's ongoing central operations

What is confirmatory value?

provides feedback about prior evaluations (you have an idea of what actually happens) i.e. compare reported NI to prior earnings forecasts winning the lottery v. wages (where income came from)

The multiple-step income statement

provides more useful information for evaluating and predicting performance than the single-step because it clearly separates key performance measures, these include: 1. Gross profit 2. Operating income 3. Income before tax (income from operations before tax when discontinued operations included 4. Income from continuing operations 5. Net income 6. Earnings per share

Point-in-time elements

represents resources, or interest in resources, as of a specific point in time and appear on the balance sheet -assets -liabilities -equity

period-of-time elements

represents the result of events and circumstances that affect the entity during a period of time -income statement -shareholder's equity

materiality threshold

requires that an item be recognized in the FS if its omission or misstatement would significantly influence the judgement of a reasonable informed statement user

cost-benefit constraint

requires that expected benefits from recognition exceed the cost of recognition

What are capital maintenance adjustments?

restatements or revaluations of reported amounts of assets and liabilities that companies usually report in other comprehensive income. A profit is earned only if the amount of net assets at the end of the period exceeds that at the beginning of the period, excluding inflows/outflows to owners -does not treat transactions with owners as separate elements 1)financial capital maintenance 2)physical capital maintenance

Assess risks or uncertainties of achieving future cash flows

some items of income are more persistent in nature than others, making them strong indicators of future cash flows.

availability bias

tendency to use the data that is most readily available or most easily recalled instead of considering all relevant data ie. friend's advice

comprehensive income

the change in equity of a business enterprise during a period from transaction and other events from nonowner sources. Includes all changes in equity except those resulting from investments by owners and distributions to owners

What is judgement?

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

General recognition

the process of reporting an economic event in the financial statements. Included in a line item on the financial statements as opposed to the notes 1) Item meets the definition of one of the elements of the FS 2) item is measurable 3) item must be reliable 4) item is relevant

free of error

there are not mistakes or omissions in the description of an event or in the process used to produce the financial information **sometimes can use estimations

Predict future performance

they provide basis for estimating future performance. Predictive value is aspect of relevance.

expense recognition principle

used to determine the period when a company reports an expense on the income statement - entity's economic benefits are consumed or future value goes down 1. match with revenues 2. expense in period occurred 3. systematically allocate over periods of use

What are enhancing characteristics (4)

used to help determine when information is relevant and represented faithfully 1) comparability 2) verifiability 3) timeliness 4) understandability

confirmatory bias

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

What is Cookie Jar?

when earnings are higher than expected in the current period, managers may elect to reduce earnings to create cookie jars reserves. They are used in future periods to increase earnings as needed.

What is Big bath?

when low earnings are expected, it involves increasing a net loss to allow the firm to show increased net income in the future. This is achieved by recognizing expenses in current periods of deferring revenue recognition to the future reporting periods.

What is earnings management?

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

groupthink bias

when members of a group, to avoid conflict, reach a consensus decision without considering all reasonable alternatives.

What is the FASB Codification? What's its purpose?

Due to the large volume of diverse and complex standards, the body of GAAP became difficult to use. In response FASB developed the ASC (Accounting Standards Codification) often referred as Codification, which summarizes al current standards by topic. Topic-subtopic-section-paragraph.

assumption

- PP&E are depreciated using assumptions about pattern of use- Investments in another company are accounted differently depending on how long management intends to hold the investment: assumptions about duration of investment

estimates

- value related to PP&E is net of accumulated depreciation: Depreciation is based upon estimates of the life and pattern of use of the depreciable assets- accts receivable estimates how much they will receive (allowance for bad debt)

What influences management behavior?

-sometimes intentionally bias their estimates (when bonuses tied to net income) -bias earnings upward if miss analysts' forcast

Elements that affect period-of-time elements U.S GAAP (7)

1) Investments by owners (issuance of stock) 2) Distributions to owners (dividends) 3) Revenues (changes in equity from norm bus operations) 4) Expenses (changes in equity from norm bus operations) 5) Gains (changes in equity not in norm) 6) Losses (changes in equity not in norm) 7) Comprehensive Income (all changes in equity except involving owners)

What are the 5 cognitive bias?

1) availability bias 2) overconfidence bias 3) confirmatory bias 4) groupthink bias 5) anchoring bias

What are the key aspects of the conceptual framework?

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

IFRS Period-of-time elements

1) performance (profit) 2) income (includes revenues and gains) 3) expenses (includes expenses and losses) 4) capital maintenance adjustments

Techniques to mitigate cognitive biases.

1. Be organized and methodical in the decision-making process 2. Generate alternatives, even when you think you have already arrived at the correct answer 3. Document your rationale about the alternatives 4. Delay your final judgement until you have gathered all the facts and information and have considered all the alternatives.

5 steps to determine timing and measurement of revenue

1. identify the contract with the customer 2. identify the separate performance obligations in the contract 3. determine the transaction price 4. allocate the transaction price to separate performance obligation 5. recognize revenue when each performance obligation is satisfied

What are judgement obstacles in preparing FS

? 1) management behavior 2) cognitive bias 3) complexity of business environment and transactions

What is the role of assumptions and estimates in the financial statements. Chapter 3. Specific examples

After an accountant determines that a firm should report a business event in the financial statements, he or she often uses assumptions and estimates to answer the following questions -when to recognize the transaction -what accounting method to use -what amount to record

Asset/liability approach vs income statement approach to developing standards

Basing the decision on whether an economic approach resource is received and it meets the definition of an asset, such as account receivable, is an asset/liability approach (balance sheet) approach. Recording based on revenue recognition criteria involves an income statement approach. In FASB's early years, it tended to focus on an income statement approach. However, in recent years it has shifted to the asset/liability approach.

What is predictive value?

Decision makers can use it as an input into processes that help forecast future outcomes i.e. reporting sales value each year

What is comprehensive income?

Net income + other comprehensive income

How to calculate EPS?

Net income/ average outstanding common shares

What companies follows the IFRS?

Over 120 countries have adopted the IFRS as their guidelines to report financial statements.

What are the elements of financial reporting

Point-in-time elements and Period-of -time elements

assets

Probable future economic benefits resulting from some past events (CFs generated from its use) 1. contribute directly or indirectly to future net CFs 2. a particular entity can obtain the benefit and control other's access to it 3. transaction has already occurred

liabilities

Probable future sacrifices of economic benefits arising from present obligations -present duty of obligation -transaction has already happened -obligates a particular entity

8. What is the cost constraint? Chapter 2

Standard setters should compare the cost of requiring financial info v. the benefits derived from presenting the info

What is IFRS?

The International Financial Reporting Standards promulgated is a set of standards developed and promulgated by the IASB (International Accounting Standards Board). It leans more towards pure principle-based approach.

WHAT IS GAAP?

The U.S. Generally Accepted Accounting Principles is collection of commonly-followed accounting rules and standards for financial reporting. These principles are developed and promulgated by FASB (Financial Accounting Standards Board), the primary standard setter In the U.S. It leans more towards pure rules-based approach.

Accrual vs Cash Based Accounting

The cash basis of accounting is not acceptable for financial reporting under U.S. GAAP. Under the cash basis, companies only recognize revenues when cash is received and expenses when cash is paid. Under the accrual basis, companies recognize revenues when earned and expenses when incurred, regardless of then cash is received or paid. Because GAAP requires the preparation of financial statements under the accrual basis, adjusting entries are needed at the end of each period.

What is the fuctional approach?

The functional approach refers to classification by the use of the expense such as: cost of goods sold (manufacturing or merchandising function), sales expenses (selling function), or administration expenses (administrative function). The GAAP allows manager to decide which one to use; however, the SEC requires reporting by function.

What companies have to follow the GAAP

The use of GAAP is not mandatory for all businesses, but the U.S. Securities and Exchange Commission (SEC) requires publicly traded and regulated companies to follow GAAP for the purpose of financial reporting.

What are the principles of recognition and measurement in financial reporting

The use of the accrual basis, rather than cash basis, is a distinguishing feature of financial accounting we discuss the underlying principles of accounting which include General recognition Revenue and expense recognition Bases of measurement

What are non-controlling interests and are such interests presented ion the income statement?

There is a non-controlling interest when one company controls another company. For example, a subsidiary, but owns less than 100 percent of it. The controlling company adds all of the subsidiary's income to its own, but since it doesn't own 100% of it, the controlling company must identify the amount that is attributable to non-controlling owners. The portion of income (loss) attributed to the non-controlling interest is deducted (added) on the income statement to arrive at income attributed to the controlling interest.

25. What is faithful representation, materiality, timeliness and relevance? Chapter 2

They are the characteristics of financial information

What are fundamental characteristics

Those basic characteristics that distinguish useful financial info from info that is not useful 1) relevance 2) faithful representation

What is the objective of financial reporting?

To provide financial information about reporting entity that is useful to existing and potential investors, lenders, and other creditors in making decisions such as buying, selling, or holding equity and debt instruments. (Decision making)