ACC 304 module 1 exam

materiality assumption

Financial information only needs to be reported if it impacts user’s decision, so small purchases like a calculator can be recorded as an expense rather than an asset

What are the accounting assumptions for depreciating equipment and machinery?

Expense recognition & historical cost

“Crosby Company lists land on its balance sheet at $120,000, its original purchase price, even though the land has a current fair value of $200,000”- What is the accounting assumption?

Historical cost (original transaction value) principle

“IBM Corporation, a multibillion-dollar company, purchased some small tools at a cost of $800. Even though the tools will be used for a number of years, the company recorded the purchase as an expense.” What is the accounting assumption?

Materiality

What is the “relevance” accounting quality? What are the examples?

Relevance- is what makes the difference in a decision

• Predictive Value – provides valuable input to investors future expectations

• Confirmatory Value – confirm or correct prior expectations

• Materiality

  • 1) material if left out would influence users decisions

  • 2) consider qualitative and quantitative.

What is the “faithful representation” accounting quality? What are the examples?

Faithful Representation – numbers of disclosure info

matches what really happened.

• Completeness – do not omit information

• Neutrality – unbiased to all interested parties

• Free from error – no material misstatements (may have errors due to estimates)

What are the enhancing qualities

• Comparability – Consistency between companies and from year to year.

• Verifiability – independent measures using same methods to get to same results

• Timeliness – having relevant information when needed.

• Understandability – classified, characterized, presented clearly and concisely.

Economic entity assumption

company activities is kept separate from its owners and other businesses.

Going concern assumption

the company will last long enough to fulfill objectives and commitments

Monetary unit assumption

basis of accounting measurement. Money is the common denominator of economic activity.

Periodicity assumption

company can divide its economic activities into time periods

What are the five “mixed attributes” GAAP has

1. Historical cost

2. Net realizable value

3. Current cost

4. Present value

5. Fair value

Historical cost principle

original transaction value adjusted for depreciation and amortization

Net realizable value

the amount of cash into which an asset is expected to be converted in the ordinary course of business

What type of account is unearned revenue

Liability account

What type of account is prepaid rent

current asset

What is the role of Financial Accounting Standards Board

Establishes and improves standards of financial accounting and reporting

What is the role of the Securities and Exchange Comission (SEC)

• SEC requires public companies to follow GAAP

• Enforcement authority

• Does not establish the standards

What are the two accounting qualities

Relevance

Faithful Representation

Revenue Recognition principle

recognize revenue in the accounting period in which the performance
obligation is satisfied.

expense recognition (matching) principle

match expenses with revenue that is generated by those expenses

full disclosure principle

provide sufficient detail of matters that make a difference.

What are the two constraints for financial reporting

• Cost

• Industry practice

Cost constraint

cost of providing info vs benefits

Industry practice

some industries have different accounting practices.

What are the objectives of financial reporting

• Provide decision-useful financial information to decision makers

  • Information on the company’s ability to generate future net cash flows

  • Management’s ability to protect and enhance the capital providers’ investment

• Decision makers:

  ▫ Current and potential equity investors, lenders, and other creditors

  ▫ Equity investors and creditors are the primary users of financial

  statements.

   Investors use information to buy, sell or hold stocks

   Lenders decide whether to let a company borrow money

• Financial statements provide most useful information at the

  lowest cost possible

What is the AICPA

American Institute of Certified Public Accountants (AICPA)

 National Professional Organization of CPAs

 No formal involvement in the standard setting process.

What is the IASB

International Accounting Standards Board (IASB)

 Establishes the International Financial Reporting Standards (IFRS).

 Used in over 120 countries.

What are the accounting standard setting steps in order

1. Research

2. Discussion paper

3. Exposure draft

4. Standard

What is the term used to indicate the whole body of FASB authoritiative literature

GAAP (generally accepted accounting principle)

GAAP vs. IFRS

• GAAP: More detailed, specific, and rules-based.

• IFRS: Simpler, more flexible, and principles-based.

• Fair Value: IFRS has adopted fair value measurements more broadly than U.S. GAAP, though both boards collaborate on convergence.

Expectations gap

The difference between what the public thinks accountants/auditors should do (guarantee zero fraud and total business success) vs. what accountants actually do (provide reasonable assurance that financials are free of material misstatement).

Modern Reporting Challenges

• Nonfinancial measurements (customer satisfaction, ESG/sustainability).

• Forward-looking information (historical cost looks backward; investors need future projections).

• Soft assets / Intangibles (brand value, intellectual property, human capital).

• Timeliness (quarterly/annual lag vs. real-time market data).

Ethics and GAAP

GAAP does not always provide a clear-cut rule for every situation; ethical judgment is required to ensure reports are not misleading.

What are the 3 levels to the Conceptual Framework (3-level pyramid)

Level 1: The Objective - “Why”- purpose of accounting

Level 2: Qualitative characteristics & Elements - Bridges between first and third level

Level 3: Recognition, Measurement, and Disclosure concepts

Level 1: The Objective - “Why”- purpose of accounting

• Provide decision-useful financial information to external capital providers (investors, lenders, creditors).

Level 2: Qualitative Characteristics & Elements (The "Bridge")

A. Fundamental Qualitative Characteristics (Must have BOTH to be useful)

1. Relevance

2. Faithful Representation

B. Enhancing Qualitative Characteristics (Improve usefulness of information)

• Comparability (and Consistency)

• Verifiability

• Timeliness

• Understandability

C. Elements of Financial Statements

• Moment in Time (Balance Sheet): Assets, Liabilities, Equity.

• Period of Time (Income Statement & Equity Changes): Investments by Owners, Distributions to Owners, Comprehensive Income, Revenues, Expenses, Gains, Losses.

Level 3: Recognition, Measurement, and Disclosure (The "How")

• Basic Assumptions

• Basic Principles

• Constraints

Steps of accounting cycle during accounting period

1. Source Documents

2. Analyze transactions

3. Journalize transactions

4. Post from journal to general ledger

Steps of accounting cycle at the end of accounting period

5. Prepare unadjusted trial balance

6. record adjusting journal entries and post to the general ledger accounts

7. prepare adjusted trial balance

8. prepare financial statements

Steps of accounting cycle at the end of year

9. Close temporary accounts to retained earnings

10. Prepare a post-closing trial balance

What are the uses of the balance sheet

• Reports assets, liabilities, and equity at a specific date

• Aids in assessing risk and predicting future cash flows

• Evaluation of company’s capital structure, liquidity, solvency and financial flexibility.

liquidity

the ability of a company to convert its assets to cash

long-term solvency

whether a company will be able to pay all its liabilities including its long-term liabilities

Financial Flexibility

the ability of a company to alter cash flows in order
to take advantage of unexpected investment opportunities and needs

Limitations of the balance sheet

• Most assets and liabilities are reported at historical cost rather than fair market value.

• Use of estimates and judgments.

• Many items of financial value are omitted (i.e. employee expertise, customer support quality).

Asset

owns or controls that is expected to provide value or benefit in the future.

liability

financial obligation—a debt or responsibility—the company must pay or fulfill in the future.

stockholder’s equity

the part of a company that belongs to its owners after all debts are subtracted.

Current assets are listed in of ____

most liquid to leastl liquid

What type of account is cash and what is its basis of evaluation

• Current asset

• fair value

What type of account is short-term investments (Debt and Equity Securities) and what is its basis of evaluation

• current asset

• generally fair value

What type of account is receivables and what is its basis of evaluation

• current asset

• estimated amount collectible

What type of account is inventories and what is its basis of evaluation

• current asset

• Lower-of-cost-or-net realizable value or

Lower-of-cost-or-market

What type of account is prepaid expenses and what is its basis of evaluation

• current asset

• cost

long-term investment

• current asset

• investments > 1 year

Property, Plant and Equipment

• long term asset

• Tangible long-lived assets used in operations

• Land, buildings , machinery, furniture, natural resources

intangible assets

• Assets that lack physical substance and are not financial instruments

• Significant economic resources

• Goodwill, Franchises, Patents, Trademarks, Copyrights

• long term asset

other assets

• long term asset

• Other items not in other categories: deferred income taxes,
  restricted cash, LT prepaid expenses, etc.

What type of account is current maturities LT debt

current liability

what is a lt liability

Obligations that a company does not reasonably expect to

liquidate within the normal operating cycle

capital stock

• Par or stated value of shares issued

• stockholder’s equity

Additional Paid-in Capital

• stockholder’ equity

• Excess of amounts paid over par or stated value

retained earnings

• stockholder’s equity

• Company’s undistributed earnings

Accumulated other comprehensive income

All changes to equity during a period except

those resulting from investments by owners and distributions to owners.

▫ Includes:

 revenues and gains, expenses and losses

in Net Income

 ains and losses that don't appear on the regular income statement but still affect equity(ex. unrealized gains and losses)

▫ Presentations

 One Statement Approach - Net Income + OCI combined in a single statement

 Statement 1: Net Income → Statement 2: Other Comprehensive Income

treasury stock

• stockholder’s equity

• company’s own stock that it has bought back from investors.

What is the purpose of statement of cash flow

provide relevant information about the cash receipts and cash payments of an enterprise during a period.

What is the usefullness of statement of cash flow

helps users of cash flow statement to evaluate the company’s liquidity, solvency and financial flexibility

Classifcations of Cash flows

• Operating activities

• investing activities

• financing activities

• non-cash activities

What goes under operating activities

• Cash Inflows

  • Sale of goods or services

  • Interest and dividends from investments

• Cash Outflows

  • Purchase of inventory

    • Salaries, wages, and other

    operating expenses

    • Interest on debt

    • Income taxes

Net cash flows from operating activies

Inflows - outflows

What goes under investing activities

• Cash Inflows

  • The sale of long-lived assets used in the business and investment securities

  • The collection of a nontrade receivable (excluding the collection of interest, which is an operating activity)

• Cash Outflows

  • Purchase of long-lived assets used in the business and purchase of stocks and bonds

  • Loans to other entities

What goes under financing activities

• Cash outflows

  • Paying dividends to owners/shareholders

  • Buying back shares previously sold to owners

  • Repaying loans/debt (e.g., notes, mortgages, bonds) — not regular trade payables

• Cash inflows

  • Selling shares to owners/investors

  • Borrowing money through loans, notes, mortgages, or bonds

Purpose of income statement

• Provides measurement of profit

Why is income statement useful

• evaluate past performance

• predict future performance

• Determine risk of achieving future cash flows

What are the limitations of income statement

• Companies omit items that cannot be measured reliably.

  • Certain investments unrealized gains/losses

  • Value of brand

  • Customer service quality

  • Product Quality

• Accounting methods used affect income

numbers

• Income measurement involves judgment

Major elements of income statement

• Revenue: inflow of assets from selling a good or service or other

activities such as investing

• Expenses: outflows or using up of assets or incurring liabilities in

order to produce goods or provide services.

• Gains: increase in equity from incidental transactions such as

sale of investments or plant assets.

• Losses: decrease in equity from incidental transactions (excludes

dividends) such as write-offs for impairments

Single-step income statement

• revenues - expenses = net income

• no distinction between operating and non-operating categories

Multi-step income statement

• Separates operating and nonoperating

transactions.

• Matches costs and expenses with related revenues.

• Highlights certain intermediate components that analysts use.

• Three sections: Operating section, nonoperating section, and income tax

Format of single-step income statement

Revenue

Expenses

Income before income taxes

Income tax expense

Income (Loss) from discontinued

operations, net of tax

Net Income

Earnings per share

Format of multi-step income statement

Net sales

Cost of goods sold

Gross profit

Operating expenses

• Selling expenses

• Administrative expenses

Income from operations

Other revenue and gains

Other expenses and losses

Income before income tax

Income tax expense

Income from continuing operations

Income (Loss) from discontinued operations, net

Net Income

Earnings per share

Earnings per share

• Widely used measure of business performance

• (net income - preferred dividends) / Weighted average per share

• Report on Income Statement – per share amounts i

  • income from continuing operations

  • Discontinued operations

  • Net Income

Various income items

-Unusual and infrequent gains and losses.

▫ Do not report net of tax

▫ Shown before income taxes with Other Revenues and

Gains or with Other Expenses and Losses

▫ Examples: impairment (write-down) of receivables,

inventory & PPE; casualty losses; restructuring

charges.

• Discontinued Operations

▫ Disposal of component of business or elimination of a component that represents a strategic shift in operations or financial results.

▫ Report net of tax.

▫ Shown after income from continuing operations but

before net income

Income statement reporting issue - Changes in accounting principle

Critieria: Change from one GAAP to another

Example: change from LIFO to FIFO

Placement on income statement: Recast prior years’ income statement on the same basis as the newly adopted principal (shown net of tax)

Income statement reporting issue - Changes in estimates

Criteria: Normal, recurring connections and adjustments

Examples: changes in realizability of receivables and inventories

Placement on income statement:

treasury stock is ___

deducted from stockholder’s equity

The qualitative characteristic that means there is agreement between a measure and a real-world phenomenon is:

representational faithfulness

Agree or disagree and what is the accounting principal? Rockville Engineering records revenue only after products have been shipped, even though customers pay Rockville 50% of the sales price in advance.

Agree, revenue recognition

collection of interest is a ____ activity

operating activity