Accounting 201: Intermediate Financial Accounting I Ch 4. Disclosure Requirements for Balance Sheets

Notes to the financial statements

give additional company information to financial statements users

Generally Accepted Accounting Principles (GAAP)

• how things are reported

• what is reported

• what is disclosed in notes

Cash Basis

records income when it’s received and expenses when payments are made

Accrual Basis

records income when a sale is made and expenses when a bill is received

Lower of cost or market

the inventory will be valued at the lowest replacement cost, whether that be the wholesale cost, or the cost that the product is sold at market

Subsequent events

things that happened after the date on the balance sheet, but before the financial statements have actually been issued

Recognized events

require changes be made to the financial statements

Unrecognized events

do not require changes be made to the financial statements

Intangibles

assets that have no physical shape or form

Consolidated financial statements

financial statements that include the financial information for not only one company, but also its subsidiaries

Contingent liabilities

a liability that has not yet occurred, but the conditions are favorable for it to occur in the near future

Financial Accounting Standards Board (FASB)

the governing board for accounting practice in the United States

The Widget Company is changing the way it does its accounting. They used to report revenue only when the money was received, but now they will report it once an order is made. How will this show in the notes?

1. As a change from a recognized event to an unrecognized event

2. As a change from market value to cost

3. As a change in amortization method

4. As a change from cash to accrual

As a change from cash to accrual

What is a liability that has not yet occurred but the conditions are favorable that it will occur called?

1. Recognized liability

2. Contingent liability

3. Subsequent event liability

4. Unrecognized event

Contingent liability

What do the notes to the financial statements do?

1. Tell how much money was made or lost in a given time period.

2. Tells how cash came in to a company and went out of a company in a given time period.

3. Tell all the accounts a company has and the balance in each.

4. Give more information to users of the financial statements about items that appear in the financial statements.

Give more information to users of the financial statements about items that appear in the financial statements.

What are the guidelines that dictate how items are reported in the body of the financial statements and what is disclosed in the notes to the financial statements?

1. GAAP

2. IFSB

3. Income statement

4. AAPA

GAAP

What are events that occurred after the date on the balance sheet but before the financial statements have been issued called?

1. Contingent Liabilites

2. Consolidated statements

3. Subsequent events

4. Lower of cost or market

Subsequent events

parenthetical disclosures

made directly on the balance sheet and immediately call the reader’s attention to significant information

summary of significant accounting principles (SSAP)

provides a brief synopsis of management’s choices of acceptable accounting principles

Identify which of the following items is usually NOT found in the summary of significant accounting principles.

1. Depreciation methods

2. Inventory flow assumptions such as FIFO and LIFO

3. Components of inventory

4. Amortization periods of goodwill

Components of inventory

Identify where the company's definition of cash equivalents would usually appear.

1. In the summary of significant accounting principles

2. In a supporting schedule

3. In the statement of retained earnings

4. As a cross-reference

In the summary of significant accounting principles

Select the correct location of balance sheet parenthetical disclosures.

1. In the footnotes

2. On the statement of cash flows

3. In the supporting schedules

4. On the balance sheet itself

On the balance sheet itself

Identify where the summary of significant accounting policies most often appears.

1. As a supporting schedule

2. In the first footnote

3. As a balance sheet cross reference

4. As a parenthetical disclosure

In the first footnote

Select the disclosure that is commonly a part of the summary of significant accounting principles.

1. Long-term debt payments for the next five years

2. The method of depreciation used

3. Components of inventory

4. Lease obligations for the succeeding five years

The method of depreciation used

International Financial Reporting Standards

adopted the capital maintenance concept of defining net income as the increase in net assets, subject to certain adjustments such as the influx of new capital, from the beginning of the period

parenthetical disclosures

• an explanation following an item intended to clarify that item

• communicate important information to the reader without the reader referencing the footnotes

Select the balance sheet account where parenthetical disclosures are very common.

1. Accrued liabilities

2. Other liabilities

3. Accounts payable

4. Common stock

Common stock

Select the FALSE statement about parenthetical disclosures on the balance sheet.

1. Parenthetical disclosures may completely replace footnotes to the financial statements.

2. Parenthetical disclosures are made right on the face of the financial statements.

3. Parenthetical disclosures highlight critical information about the balance sheet for the reader.

4. Parenthetical disclosures are not required by accounting regulators.

Parenthetical disclosures may completely replace footnotes to the financial statements.

Identify which of the following is NOT a method of enhancing balance sheet disclosure.

1. Cross-references

2. Parenthetical disclosures

3. Statement of cash flows

4. Supporting schedules

Statement of cash flows

Which of the following statements is TRUE?

1. Parenthetical disclosures are made in the footnotes, helping to explain the footnotes.

2. Parenthetical disclosures are made right on the face of the balance sheet, highlighting important information for the user of the financial statements.

3. Parenthetical disclosures are made in the supporting schedules, helping to explain the supporting schedules.

4. Parenthetical disclosures are not required under generally accepted accounting principles.

Parenthetical disclosures are made right on the face of the balance sheet, highlighting important information for the user of the financial statements.

Identify the definition of net income, according to the capital maintenance concept.

1. Net income is the growth in assets from the beginning of the period.

2. Net income is defined as sales less cost of goods sold.

3. Net income is the growth in liabilities from the beginning of the period.

4. Net income is essentially the increase in net assets from the beginning of the period.

Net income is essentially the increase in net assets from the beginning of the period.

balance sheet

one of the four basic financial statements

capital maintenance theory

states net income is determined solely by the increase in net assets from one period to the other

cross-referencing

a technique used to enhance a reader’s understanding of the balance sheet

Which of the following specifies when balance sheet accounts may be cross-referenced?

1. When there's no relationship between the two accounts.

2. When there's a direct relationship between the two accounts.

3. Cross-referencing is not permitted under any circumstance.

4. Only unrelated balance sheet accounts may be cross-referenced.

When there's a direct relationship between the two accounts.

Select the answer that is NOT a technique used to directly enhance understanding of the balance sheet.

1. Cross-referencing

2. Description of the company's marketing plan

3. Parenthetical disclosures

4. Descriptive footnote disclosures

Description of the company's marketing plan

Select the example of balance sheet cross-referencing.

1. Inventory serving as collateral for a loan cross-referenced to loans payable and vice versa

2. Footnote disclosure of inventory categories cross-referenced to loans payable and vice versa

3. The number of common shares outstanding cross-referenced to loans payable and vice versa

4. An accounts receivable valuation account cross-referenced to loans payable and vice versa

Inventory serving as collateral for a loan cross-referenced to loans payable and vice versa

Identify the theory that has recently brought more attention to the importance of the balance sheet.

1. Disclosure theory

2. Efficient frontier theory

3. Cross-referencing theory

4. Capital maintenance theory

Capital maintenance theory

Select the secondary use of the term cross-referencing when used on financial statements.

1. There's no secondary use of the term cross-referencing in accounting.

2. A parenthetical disclosure is placed on a balance sheet account.

3. A balance sheet account contains a reference to an explanatory footnote.

4. A balance sheet account is linked to another account that it is directly related to.

A balance sheet account contains a reference to an explanatory footnote.

deferred tax assets

the tax benefit that can be taken in future years to offset current losses

valuation allowance

offsets part of a company’s deferred tax assets

Where should valuation allowance be noted?

1. As an offset of the deferred tax asset on the asset side of the balance sheet

2. As a note on the bottom of the balance sheet

3. As a tax liability in the short-term

4. As a supplement schedule to the balance sheet

As an offset of the deferred tax asset on the asset side of the balance she

Using deferred tax assets allows a company to do what?

1. increase part of the of taxable income for a company

2. reduce the total amount of taxable income for a company

3. earn interest on part of the taxable income for a company

4. increase the total amount of taxable income for a company

reduce the total amount of taxable income for a company

As a general rule of thumb, when should a company include a valuation allowance?

1. When 50% of the deferred tax asset won't be realized

2. When there is a 100% chance a portion of the deferred tax asset won't be realized

3. When there is a 50% chance a portion of the deferred tax asset won't be realized

4. The year before a portion of the deferred tax asset will expire

When there is a 50% chance a portion of the deferred tax asset won't be realized

How long does a company have to use a deferred tax asset?

1. The year in which the asset was attained

2. Seven years after the tax loss creating the asset

3. Two years after the tax loss creating the asset

4. Indefinitely.

Indefinitely.

What are a company's deferred tax assets?

1. Taxes already paid

2. Assets that grow tax deferred

3. Assets used to offset future earnings

4. Taxes it has yet to pay

Assets used to offset future earnings

supporting schedules

additional details about balance sheet entries that are made as supplements

Who does added transparency of supporting schedules seek to protect?

1. The owners of the short-term marketable securities

2. The CEO of the company

3. The debt holders of the company

4. The shareholders of the company

The shareholders of the company

Which balance sheet entry would not typically get a supporting schedule?

1. Any liability

2. Any current asset

3. Shareholder equity

4. Any long-term asset

Shareholder equity

Sarah's Salon owns stock in beauty companies. She owns 10 shares priced at $125 of Gorgeous Co, 25 shares priced at $50 of Luscious Co, and 75 shares of Beautiful Co. priced at $25. What is the total amount of securities she owns?

1. $6,250

2. $4,375

3. $4,000

4. $3,750

$4,375

Why would shareholders want to see a supporting schedule detailing long-term notes payable for the company?

1. To determine the credit quality of the company

2. To limit long-term liability

3. To know when future liabilities must be paid

4. To add more debt to the balance sheet

To know when future liabilities must be paid

Don's Drones has $100,000 in inventory composed of blades, bases and bodies. Its inventory of blades is $30,000 and its inventory of bases in $20,000. How much of its inventory is bodies?

1. $100,000

2. $50,000

3. $70,000

4. $150,000

$50,000

related party

a person or entity that's somehow related to the entity putting together a financial statement

related-party transaction

any purchase or agreement made between two related entitities

Who does related-party disclosure protect the most?

1. The related-parties themselves

2. Business affiliates

3. Board members of the companies involved

4. Shareholders of the companies involved

Shareholders of the companies involved

Which of the following would NOT be a related-party transaction?

1. A lease agreement

2. A partnership agreement

3. The rendering of services

4. The purchase of goods

A partnership agreement

Which of the following is NOT required as part of related-party disclosure?

1. Nature of the relationship

2. A description of the transaction

3. The dollar amount of the transaction

4. Major shareholders of the company

Major shareholders of the company

Which of the following would NOT be considered a related-party?

1. A vendor

2. A blood relative of the owner

3. A subsidiary

4. A business affiliate

A vendor

Which two parties are most commonly involved in related-party transactions?

1. Parent company and subsidiary

2. Shareholder groups and business affiliates

3. Business affiliates and subsidiaries

4. Parent company and shareholder groups

Parent company and subsidiary

When preparing financial statements, any transactions among partners, associates, family members, management, or other business owners is defined as a _____ .

1. intercompany transaction

2. related-party transaction

3. business transaction

4. full-disclosure transaction

related-party transaction

A related-party transaction occurs when two parties _____.

1. have a relationship prior to a business deal

2. bill one another for professional services

3. share money in business accounts

4. both speak the same language

have a relationship prior to a business deal

Examples of related-party transactions include _____.

1. buying goods from a common third-party supplier

2. sales or purchases, transfer of property, and exchanges of professional services

3. paying monthly mortgage to the bank

4. paying payroll taxes for employees

sales or purchases, transfer of property, and exchanges of professional services

Related-party transactions can present a risk to a company, including:

1. Paying bills late

2. Financial reporting misstatement or fraud

3. Limiting professional services

4. Loose auditing controls and focus

Financial reporting misstatement or fraud

Doing business with a related party does not necessarily require that a company have a different process to manage those transactions but rather that it _____.

1. relies on outside organizations, such as the SEC, to manage those transactions

2. relies on lawyers to manage those transactions

3. avoids such transactions altogether

4. has internal controls in place to mitigate risk and fraud

has internal controls in place to mitigate risk and fraud

comparative balance sheets

• enable you to discern the trends in the company’s financial position

• allow an analyst to see how the composition of a company’s assets and liabilities have changed over the year

comparative financial statement presentation

two or more balance sheets of succeeding periods are often presented in a side by side comparison

Securities and Exchange Commission (SEC)

requires all publicly traded companies to present comparative financial statements in their filings

horizontal balance sheet analysis

compares differences in line items or ratios over time

vertical analysis of the balance sheet

calculating the percentage of each caption of the balance to total assets

Select the following correct statement about the number of balance sheets reported in financial statements.

1. The SEC requires public companies to present at least three balance sheets in their annual report.

2. An independent auditor can NOT issue an opinion on just one balance sheet.

3. Private companies are encouraged to present comparative balance sheets.

4. Comparative balance sheets are required for all companies.

Private companies are encouraged to present comparative balance sheets.

Which caption on the balance sheet is used as the denominator for all vertical analysis computations?

1. Cash

2. Accounts receivable

3. Total assets

4. Current assets

Total assets

Why are comparative balance sheets desirable?

1. Comparative balance sheets are presented only because the SEC requires it.

2. Comparative balance sheets reduce the risk of mistakes in financial statements.

3. There is no use to comparative balance sheets, which is why you can present only one if you wish

4. A reader can discern trends from one period to another.

A reader can discern trends from one period to another.

In what order must balance sheets be presented?

1. A balance sheet does not need to be presented in the financial statements.

2. The newest balance sheet must be presented first.

3. The SEC requires all financial information to be presented in the same chronological order throughout the financial statements.

4. The oldest balance sheet must be presented first.

The SEC requires all financial information to be presented in the same chronological order throughout the financial statements.

Identify two common types of trend analyses performed on the balance sheet.

1. Horizontal and vertical analyses

2. Statistical and vertical analyses

3. Vertical and stress analyses

4. Horizontal and statistical analyses

Horizontal and vertical analyses

subsequent event

a real event occurring after the date of the balance sheet but before the issuance of the financial statements of a public company

recognized subsequent event

occurs after the balance sheet date but provides additional information about conditions and estimates made as of the balance sheet date

non-recognized subsequent event

occurs after the balance sheet date and provides evidence about events or conditions that didn’t exist at the balance sheet date

generally accepted accounting principles

requires you to review the period after your balance sheet for subsequent events and to make the necessary adjustments or disclosures as required

Select the correct financial statement accounting for a recognized subsequent event.

1. The financial statements must be adjusted for the effects of the recognized subsequent event

2. A recognized subsequent event may be ignored since it occurred in the period after the financial statements

3. Footnote disclosure only is required for a recognized subsequent event

4. No recognition is permitted in the financial statements

The financial statements must be adjusted for the effects of the recognized subsequent event

Identify which event is NOT a non-recognized subsequent event.

1. Damage to your inventory after the balance sheet date due to a flood

2. A customer default immediately after the balance sheet date due to the customer's insolvency

3. A sale of your company's stocks or bonds before the balance sheet date

4. A loss from litigation settlement shortly before the balance sheet date

A customer default immediately after the balance sheet date due to the customer's insolvency

Identify the correct alternative names for recognized and non-recognized subsequent events.

1. Recognized and Type 1 subsequent events

2. Type 1 and Type 2 subsequent events

3. Disclosed and undisclosed subsequent events

4. Recorded and unrecorded events

Type 1 and Type 2 subsequent events

Select the correct statement about non-recognized subsequent events.

1. Non-recognized subsequent events provide evidence about conditions and accounting estimates made as of the balance sheet date

2. Non-recognized subsequent events may be ignored since they occurred after the balance sheet date

3. Non-recognized subsequent events are accounted for as prior period adjustments

4. Non-recognized subsequent events provide information about conditions that did not exist as of the balance sheet date

Non-recognized subsequent events provide information about conditions that did not exist as of the balance sheet date

Identify the correct type of event to describe the following circumstance: A litigation loss resulting from a lawsuit filed in the prior year and being finalized after the balance sheet date but before the issuance of the financial statements.

1. A prior period adjustment

2. A recognized subsequent event

3. A change in accounting estimate

4. A non-recognized subsequent event

A recognized subsequent event

contingency

a situation where the outcome is uncertain and the situation will be resolved sometime in the future

loss contingency

the future outcome is most likely to result in a liability

gain contingency

the future outcome is most likely to result in an asset

What is the disclosure needed for a lawsuit where it is probable, but not reasonably estimable how much the company will need to pay?

1. disclosure note only

2. loss account and disclosure note

3. loss account only

4. no disclosure is needed

disclosure note only

If a lawsuit against the company is probable and the amount they need to pay is known then the company needs to record _____

1. just a loss contingency

2. a loss contingency and a disclosure note

3. nothing

4. just a disclosure note

a loss contingency and a disclosure note

_____ is recorded for a gain contingency on the balance sheet.

1. Revenue

2. The exact opposite entry for a loss contingency

3. The same entry for a loss contingency

4. Nothing

Nothing

When a loss contingency needs to be recorded, the accountant will debit _____ and credit _____.

1. loss payable, loss expense

2. loss expense, loss payable

3. loss revenue, loss payable

4. loss payable, loss revenue

loss expense, loss payable

A(n) _____ is a situation where the outcome is uncertain, and the situation will be resolved sometime in the future.

1. contingency

2. asset

3. equity account

4. liability

contingency