Financial Accounting: Key Concepts, Statements, and Regulatory Bodies

What is financial accounting?

Financial accounting is the process of identifying, measuring, and communicating financial information about an economic entity to various user groups within the political, legal, and economic environment.

List some user groups

equity investors, government agencies, debt investors, creditors, competitors, financial analysts, employees and labor unions

What are the 4 financial statements

1. the balance sheet (aka statement of financial position)

2. statement of comprehensive income

3. statement of cash flows

4. statement of shareholders' equity

What are other sources of financial information?

a letter to shareholders, auditor's report, financial summary, management report, footnote disclosures, a formal discussion and analysis

List the type of economic entities

corporations, partnerships, sole proprietorships, government organizations

What does SEC stand for

Securities and Exchange Commission

What does FASB stand for? What created FASB? and what is the role of FASB

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What is the distinction between fundamental characteristic and enhancing characteristic?

fundamental are the basic characteristics of reporting v enhancing helps determine more useful information

What are the two fundamental characteristics and their attributes?

relevance and faithful representation.

Relevance: financial information is relevant, if it is capable of making a difference in decision making by exhibiting the following attributes.

1. predictive value: information has predictive value if decision makers can use it as an input into processes that help forecast future outcomes

2. confirmatory value: information has confirmatory value if it provides feedback about prior evaluations.

3. materiality: information is material if reporting it inaccurately or omitting it would affect financial statement users' decisions.

Faithful representation: does it represent what it intends to- to determine this information has to be:

1. complete: the depiction of an economic event is considered complete if it includes all information-both descriptions and explanations--necessary for the financial statement user to understand the underlying economic event.

2. Neutral: information is neutral if it is free from bias in both the selection and presentation of financial data

3. Free from error: information is free from error when there are no mistakes or omissions in the description of an event or in the process used to produce the financial info.

Application Questions

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1. FASB requires disclosures related to long-term debt that specify how much debt is coming due in each of the next 5 years

2. A corporation discloses both favorable and unfavorable tax settlements

3. Investors use current year earnings to evaluate analysts' forecast of earnings

4. There is an error in the accounting system such that debits are flowing to advertising expense instead of utility expense

5. Investigators uncover a $10,000 fraud in a very large company-fraud perpetrated by top management

6. A financial analyst uses current year earnings as in put into forecasting next year's earnings

1. complete

2. neutral

3. predictive value

4. free from error

5. materiality - (*fraud is always material)

6. predictive value

What are the four enhancing characteristic?

1. comparability allows financial statements users to identify and understand similarities and differences among several entities. comparing financial information is useful if financial statement users can compare it with similar information from another company, companies in its industry, or itself at another period of time.

2. verifiability means that a group of reasonably informed financial statement users are able to reach a consensus decision that reported information is a faithful representation of an underlying economic event

3. timely information is available to financial statement users early enough to make a difference in decision making.

4. information is understandable to reasonably informed financial statement users when financial statements classify, characterize, and clearly present all information.

Application questions

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1. A bank reconciliation comes up with a cash balance of $250,000

2. Current assets are reported separately from non-current assets on the balance sheet.

3. Public companies are required to file quarterly financial reports

4. All firms are required to estimate and report bad debt expense?

1. verifiability

2. understandable

3. timely

4. comparable

What is the difference between point in time elements v period of time elements?

Point in time: this is the balance sheet. represent resources, claims to resources, or interests in resources as of a specific point in time

- Elements

1. Assets: present right of an entity to an economic benefits

2. Liabilities: present obligation of an entity to transfer an economic benefit

3. Equity: The net assets or residual interest in the assets of an entity that remains after deducting its liabilities

Period of time: this is the income statement. presents statement of cash flow- doesn't introduce new accounts or elements. There are four main accounts on income statement.

1. Revenue: inflow from delivering or producing goods, services, etc

2. Gain: peripheral on the side, not from your core business

3. Expenses: outflow from delivering/producing goods, or rendering services, etc.

4. Losses: decreases in equity from transaction and other events and circumstances

What is recognition?

putting it on the financial statement through journal entries

What are the 3 main approaches to determine when to recognize an expense?

1. the item meets the definition of one of the elements of financial statements (e.g. assets)

2. The item is measurable. (e.g. contingent liability)

3. The entity must be able to depict and measure the item with faithful representation.

*Note that we also must consider the cost-benefit constraint and materiality.

-The cost-benefit constraint requires that the expected benefits from recognition exceed the costs of recognition.

What is measurement? What are the two measurement bases under US GAAP

some monetary unit

1. entry price: price paid to acquire an asset or received to assume a liability in an exchange transmission

2. exit price: price received to sell an asset or paid to transfer or settle a liability in an exchange transaction

*the exit price is consistent with fair value reporting

What is judgement? What are the pros and cons of judgement? What are factors that influence judgement

using your estimation.

pros:

cons:

1. comparability is hard

2. can hide fraud

Factors influencing judgement:

1. cognitive bias

2. external pressures like management compensation, analysts' forecast, and other benchmarks (e.g. prior quarter earnings)