Financial Accounting Chapter 1
Out of 174 Jurisdictions Worldwide
96 require IFRS for all firms 10 require IFRS for some firms 25 permit IFRS 23 do not permit IFRS 20 do not have stock exchanges
The four different approaches to implementing expense recognition are:
1. Recognizing an expense based on an exact cause-and-effect relationship between a revenue and expense event. Cost of goods sold is an example of an expense recognized by this approach. 2. Recognizing an expense by identifying the expense with the revenues recognized in a specific time period. Office salaries are an example of an expense recognized by this approach. 3. Recognizing an expense by a systematic and rational allocation to specific time periods. Depreciation is an example of an expense recognized by this approach. 4. Recognizing expenses in the period incurred, without regard to related revenues. Advertising is an example of an expense recognized by this approach.
Going concern assumption
Assume the business will continue to operate indefinitely
What is comprehensive income?
Comprehensive income is defined as the change in equity of an entity during a period from nonowner transactions.
Accrual Accounting
Depicts the effects of transactions and events in the periods in which they occur, even if the resulting cash receipts and payments occur in a different period Allows for better assessment of the company's past and future performance than the SOCF in that period
Need for Accounting Standards
Facilitate clear and consistent financial reporting, companies tend to report only what is required. Without GAAP it would be impossible to compare companies financial statements because they would have all been prepared differently
What are the four accounting principles?
Four accounting practices, often referred to as principles, that guide accounting practice are (1) revenue recognition, (2) expense recognition, (3) mixed-attribute measurement (including historical cost), and (4) full disclosure.
What is meant by the term materiality in finance reporting?
Information is material if it is deemed to have an effect on a decision made by a user. The threshold for materiality will depend principally on the relative dollar amount of the transaction being considered. One consequence of materiality is that GAAP need not be followed in measuring and reporting a transaction if that transaction is not material. The threshold for materiality has been left to subjective judgment.
Accounting info helps which users make decisions
Investors Creditors Customers Supplies Regulators Financial Intermediaries
Cash basis accounting
Produces Net Operating cash Flow Difference between cash receipts and cash payments
Realization Principle
Recognize revenue when the earning process is virtually complete and collection is reasonably assured
Matching Principle
Recognizes expenses in the same period as the revenues they help generate
Facts about the SEC
Relies on the FASB to develop accounting standards, but the SEC enforces. IASB sets the standards for international use
Conservatism
Require greater verification before recognizing gains than losses
What should you tell your friend about the presence of accounting standards in the US compared to the rest of the world? Who has the authority for standard setting? Who has responsibility?
SEC but it is delegated to private sector
What is the standard setting body responsible for determining IFRS? How does it obtain its funding?
The International Accounting Standards Board (IASB) is responsible for determining IFRS. The IASB is funded by the International Accounting Standards Committee Foundation (IASCF), which in turn receives much of its funding through voluntary donations by accounting firms and corporations.
Objectives of Accounting Standars
To provide information to users that -is useful in making investment, credit and other decisions -helps assess the amounts, timing and uncertainty of future net cash flows -portrays the company's resources, obligations and how effectively the company has used its resources
Under the asset/liability approach,
assets and liabilities are considered primary, and revenues and expenses are secondary in the sense of being recognized at the time and amount necessary to allow recognition and measurement of assets and liabilities as required by their definitions.
Measurement bases
historical cost, current cost, net realizable value, PV of cash flows of fair value
The reported item should be useful in decision making
relevant representational faithful
Under the revenue/expense approach,
revenues and expenses are considered primary, and assets, liabilities, and equities are secondary in the sense of being recognized at the time and amount necessary to achieve proper revenue and expense recognition.
Cash vs Accrual Accounting
Accrual accounting provides a better depiction of the periodic operating performance of the company. -It is generally more predictive of FCF Accrual Accounting requires judgment, which can be subjective
Means of Financial Reporting
Annual Report -Financial Statements -Notes to the Financial Statements -Management's discussion and analysis Other Filings with SEC Filings with other regulatory agencies Conference Calls Press Releases
What is equity?
Equity is the residual interest in the assets of any entity that remains after deducting its liabilities.
Need for Financial Reporting
Information asymmetry describes where one party has better information than another. -company has a better info about its financial state than do current or potential investors Info asymmetry prevents efficient capital allocation, which is critical for growth Financial Reporting can minimize info asymmetry
What are the competes of relevant information and faithful representation
The components of relevant information are predictive value, confirmatory value and materiality. The components of faithful representation are completeness, neutrality, and freedom from error.
What are the four basic assumptions underlying GAAP?
The four basic assumptions underlying GAAP are (1) the economic entity assumption, (2) the going concern assumption, (3) the periodicity assumption, and (4) the monetary unit assumption.
What is the going concern?
The going concern assumption means that, in the absence of information to the contrary, it is anticipated that a business entity will continue to operate indefinitely. This assumption is important to many broad and specific accounting principles such as the historical cost principle.
GAAP prioritizes the inputs companies should use when determining fair value. They include;
The highest and most desirable inputs, Level 1, are quoted market prices in active markets for identical assets or liabilities. Level 2 inputs are other than quoted prices that are observable, including quoted prices for similar assets or liabilities in active or inactive markets and inputs that are derived principally from observable related market data. Level 3 inputs, the least desirable, are inputs that reflect the entity's own assumptions about the assumptions market participants would use in pricing the asset or liability based on the best information available in the circumstances.
Explain the periodically assumption.
The periodicity assumption relates to needs of external users to receive timely financial information. This assumption requires that the economic life of a company be divided into artificial periods for financial reporting. Companies usually report to external users at least once a year.
What are two advantages of recording assets and liabilities based on there historical cost?
Two advantages to basing valuation on historical cost are (1) historical cost provides important cash flow information since it represents the cash or cash equivalent paid for an asset or received in exchange for the assumption of a liability, and (2) historical cost valuation is the result of an exchange transaction between two independent parties and the agreed upon exchange value is, therefore, objective and possesses a high degree of verifiability.
What are the functions of the conceptual framework under IFRS?
Under IFRS, the conceptual framework provides guidance to accounting standard setters but also provides GAAP when more specific accounting standards do not provide guidance.