Chapter 1 accounting blum

blum

management

Preparation, guided by GAAP [Generally Accepted Accounting Principles]

auditors

Verification, guided by GAAS [Generally Accepted Auditing Standards]

Financial statement users

Resource allocation decisions

SEC (securities and exchange commission

Reporting & enforcement, SEC regulations

FASB (financial accounting standards board)

Standard setting, determines GAAP with input

from stakeholders

Stock Market Crash (1929) → SEC Created (1934)

SEC established to ensure accurate, comparable financial information and investor confidence

Need for Independence → FASB Created (1973)

FASB established as independent standard-setter with Conceptual Framework for principle-based standards

Objective of General-Purpose Financial Reporting

Provide financial information about the reporting entity that is useful to existing and potential investors, lenders, and other creditors in making decisions about providing resources to the entity.

Relevance

Capable of making a difference in decisions of users

Predictive value

used as an input to predict future outcomes

Confirmatory value

provides feedback about previous evaluations

Materiality

omission or misstatement would influence a reasonable user’s judgment

faithful representation

Represents economic phenomena in words and numbers

Completeness

all information necessary for user to understand the phenomenon

neutrality

without bias in selection or presentation of financial information

free from error

no errors/omissions in description or in process to develop

comparability

information can be compared across companies or time periods

verifiability

different knowledgeable and independent users would reach a consensus that information is faithfully represented

Timeliness

available in time for the information to influence users’ decisions

Understandability

A reasonably well-informed user can understand after diligent review and analysis, and potentially seeking help with understanding complex phenomena

Cost effectiveness

Cost is a pervasive constraint on the information that can be provided by financial reporting. Reporting financial information imposes costs, and it is important that those costs are justified by the benefits of reporting that information.

recognition

Incorporating an item that meets an element's definition in financial statements once three recognition criteria are satisfied

3 recognition criteria

definitions, measurability, faithful representation

definitions

Item meets the definition of an element

measurability

item is measurable with a relevant measurement system

Faithful Representation

Item can be depicted and measured with faithful representation

Derecognition

Removing a previously recognized item when it no longer meets the definition or recognition criteria

guiding principle

Assets should not be reported at more than recoverable amounts; liabilities should not be reported at less than settleable amounts.

key point

More than one measurement system is necessary to meet the objective of financial reporting.

disclosure process

Disclosure is used to amplify/complement recognized items

economic entity

Separate entity from the owners

monetary unit

Changes in purchasing power of the dollar are immaterial, report in USD

going concern

Entity will continue operations into the foreseeable future

Periodicity

Economic activities can be divided into unique time periods (month, quarter, year)

accrual basis key principle

Record economic effects in the periods when events happen, even if cash receipts and payments occur in different periods.

accrual

Recognizing assets or liabilities (and related revenues/expenses) before cash is received/paid

deferral

Recognizing an asset from current cash payment or a liability from current cash receipt, with revenues/expenses recognized later

allocation

Systematically adjusting an asset or liability over multiple periods as economic benefits are consumed or obligations are satisfied

Why Accrual Accounting Matters:

Research consistently shows that earnings are better predictors of future cash flows than current cash flows are, because accrual accounting removes timing noise.

Accruals

Income Statement before Cash

Accrued Revenues

Performance obligation satisfied, but not yet received in cash or recorded.

Accrued Expenses

Expenses incurred, but not yet paid in cash or recorded

Deferrals

Cash before Income Statement

Deferred Expenses

Expenses paid in cash and recorded as assets before they are used or consumed

Deferred Revenues

payments received in cash and recorded as liabilities until the performance obligation is satisfied.

unusual and frequent items

Separately stated on the income statement (Never net of taxes), disclosed in financial statements

permanent Items represent ongoing, ordinary business operations

Expected to recur in future periods

Transitory Items result from unusual, non-recurring events

Expected to NOT recur in future periods

discontinued operations

A business component (with its own identifiable operations and cash flows) is being eliminated. Strategic

When the Discontinued Component is sold before the end of the reporting period, income from discontinued operations include:

Earnings from the discontinued component through the disposal date. Gain or loss on disposal of the component.

Other comprehensive income

Comprehensive income includes all changes in equity during a period except those resulting from investments by owners and distributions to owners.

changes in estimates

Normal, recurring adjustments from periodic revisions in estimates

current assets

Resources expected to be turned into cash, sold, or consumed within a year or the operating cycle, whichever is longer.

operating cycle

Average length of time intervening between the acquisition of materials or services and the final cash realization

non-current assets

Expected conversion to cash at some date beyond one year or the operating cycle

current liabilities

Obligations expected to be liquidated within one year or the operating cycle.

non-current liabilities

Obligations reasonably expected to be liquidated at some date beyond one year or the operating cycle, whichever is longer.

stockholders equity

Residual interest after total liabilities are subtracted from total assets.

operating activities

Related to net income generation.

investing activities

Related to acquiring/disposing of fixed assets and investments, making/collecting loans.

financing activities

Related to the issuance of debt and equity securities.