PART 1-SEC A: External Financial Reporting Decisions

Flashcards covering key concepts related to external financial reporting decisions, including definitions of financial statements, terms related to financial transactions, and accounting principles.

Balance Sheet

A financial statement showing the financial position (assets and claims on those assets) of an organization at a specific point in time. Example: As of December 31, 20X1

Preferred shares

Contributed capital for non-voting stock at par value. Are not reported as a liability. They are reported within owner’s equity.

Putable bonds

Bonds that give the bondholders the right to sell the bonds back to the issuer prior to the bonds' maturity date.

Income Statement

A financial statement showing the results of operations (revenues minus expenses, losses, and taxes) for an organization over a period. Ex: for the year ended December 31, 20X2

Statement of Changes in Equity

A financial statement that shows the changes in capital received and retained earnings for a fiscal period. Ex: for the year ended December 31, 20X2

Statement of Cash Flows

A financial statement that presents the change in cash and cash equivalents classified as operating, investing, or financing for a period. More reliable; does not employ accrual accounting. Ex: for the year ended December 31, 20X2

Net Realizable Value (NRV)

The value at which accounts receivable are carried on the balance sheet, calculated as gross accounts receivable less the allowance for credit losses. The amount that is expected to be collected in the future.

Operating Activities

Cash flows related to normal business operations; includes cash from customers and cash paid to employees and suppliers.

Investing Activities

Cash flows related to the purchase and sale of long-term assets and investments.

Financing Activities

Cash flows related to long-term liabilities or equity, including debt issuance and stock dividends.

Integrated Reporting (IR)

A process founded on integrated thinking that results in a report about value creation over time.

Human Capital

The expertise and abilities (including potential, motivation, attitude, ethical principles, and leadership) of the people within an organization.

Social Capital

The relationships within an organization, as well as between the organization and its external stakeholders (including community, government, suppliers, competitors, customers, etc.).

Inventory Valuation

The method used to assign costs to inventory, including FIFO, LIFO, and average cost.

Deferred Income Tax Asset

A future tax benefit arising from temporary differences between the handling of revenues and expenses for financial reporting versus tax purposes.

Finance Lease

A lease that transfers all risks and rewards of ownership of the asset to the lessee.

Operating Lease

A lease where all risks and rewards of ownership remain with the lessor.

Accrual Accounting

An accounting method where revenue and expenses are recorded when they are earned or incurred, regardless of when cash is received or paid.

Matching Principle

The principle that expenses should be matched to the revenues they help generate.

Impairment

A permanent reduction in the value of an asset, determined by the recoverability test for long-term and intangible assets.

If the bonds are trading at $101

it means that the fair value of the bonds is higher than the face value of the bonds. Because the bonds are liabilities, it is not in the firm’s benefit to report the liabilities at a higher amount.

$28 million in outstanding bonds trading at $98

It would be reported at 98% of $28 million using fair value accounting, or $27,440,000. It would be to the firm’s benefit to be able to report its liability at lower than nominal, or face, value.

Perpetual LIFO inventory pricing

For each individual sale we need to determine what the most recently purchased items in inventory were and then these units will be the first ones sold in the next sale and removed from inventory.

Perpetual LIFO

Applies LIFO at the time of each sale.

Periodic LIFO

Applies LIFO at the end of the period, considering all purchases and sales during the period.

LIFO

Often used for tax advantages in rising price environments (higher COGS → lower taxable income). Requires detailed recordkeeping.

Examples of Operating Activities

Interest payments. Items involving the calculation of NI like wages. Purchase of raw materials (operating outflow), Dividends received. Gain/loss on sale of equipment.

Examples of Investing Activities

Purchase of Sale of long-term assets. Proceeds from selling equipment. Purchase of PPE. Cash flows related to cash the company has loaned to others (note receivable). Buying and selling of stocks/bonds of another company.

Examples of Financing Activities

Transactions with shareholders & borrowing/repaying debt. Changes in bank overdrafts. Redeeming bonds (repayment of debt). Cash flows related to cash the company has borrowed from others. Buying back stock on the open market (treasury stock) and reissuing it.

Non-cash Activities

Conversion of bonds to common shares. Direct issuance of CS to purchase assets. Direct issuance of debit to purchase assets.

Assets

The resources available for carrying out the purposes of the organization (such as cash, accounts receivable, inventory, or property and equipment).

Liabilities

Claims on the assets of the organization, such as amounts owed for debt, accounts payable, and wages payable.

Equities

Owners' claims on the assets of the organization, which can arise through owner contributions (i.e., stock) or retained earnings.

Common stock

(at par value, if applicable): contributed capital for voting stock.

Additional paid-in capital

Contributed capital in excess of par values.

Treasury stock

A record of stock repurchased by the organization.

Retained earnings

Accumulated net income earned less any dividends declared.

Accumulated other comprehensive income

Accumulated income items not included in net income.

Periodicity

Reporting periods don't match business cycles.

Historical information

Reports are inherently backward-looking.

Valuation

Variation in measurement methods.

The limitations of each financial statement

Periodicity, Historical information, Valuation, Accounting methods, Omissions.

Net income

Connected to the balance sheet through the change in retained earnings, which is also shown in the statement of changes in shareholders’ equity. The balance sheet change in cash is presented in the statement of cash flows.

Integrated thinking

An inclusive process of decision making and management that is based on the connections and interdependencies across a wide range of factors that affect value creation in organizations.

The integrated report

A communication about how an organization's strategy, governance, performance and prospects, in the context of its external environment, lead to value creation.

Primary purpose of IR

To provide stakeholders with enhanced information, both financial and nonfinancial, about how an organization uses resources across a variety of dimensions to create value.

Value creation

Refers to actions that increase the worth of goods and services. More broadly, it refers to the use of resources to enhance an organization's long-term competitiveness and growth. Value creation is being increasingly recognized as a better organizational goal than the improvement of strict financial measures of performance.

IR framework Six Capitals

Stocks of value that can be increased, decreased, or transformed through the activities of an organization. Natural capital, Financial capital, Human capital, Social capital, Intellectual capital, Manufactured capital.

Natural capital

Environmental and biological resources, such as water, timber, minerals, etc., which can be used by organizations to provide a return.

Financial capital

Funds which can be used by an organization to produce goods and provide services.

Intellectual capital

Intangible assets associated with organizational capabilities and knowledge (including intellectual property such as patents, copyrights, software, and licenses, as well as organizational capital such as tacit knowledge, systems, procedures, etc.).

Manufactured capital

Manufactured physical objects (such as buildings, equipment, and infrastructure) that an organization uses for the production of goods or the provision of services.

Benefits of adopting IR

Better understanding of the relationship between financial and nonfinancial performance, improved internal measurement and control systems for the production of information, lower reputational risk, greater employee engagement, and improved relationships with external stakeholders.

Challenges of adopting IR

Lower recognition of IR relative to traditional financial reporting, the lack of widespread adoption or assurance, and lower availability of systems and processes for producing integrated reports.

Cost recovery method

Profit will not be recognized until the cash collected exceeds the cost of the item sold (book value).

Investments in available-for-sale securities are reported at

Fair value on the balance sheet, with unrealized gains or losses reflected in other comprehensive income.

Whether receivables are sold with recourse or without recourse, the sold receivables need to be

written off

Warranty expense for a period is calculated as

Sales × Expected Warranty Cost % - Recognized in the current period, even if costs are incurred later.

Cost of goods sold formula

beginning inventory + purchases − ending inventory