O'Rourke Intermediate Accounting Exam 1 Ch. 1-2 Flash Cards

Financial Accounting

Identifying and communicating financial information of an economic entity to user groups

Objective of financial reporting

To provide useful financial information about the entity to the users of the reports

Primary users of financial information

Investors, lenders, and other creditors

Four major elements of financial accounting

Financial information, economic entity, user groups and legal/economic/political/social environment.

Governed financial information

Financial statements and footnotes to financial statements

Ungoverned financial information

Letter to owners

Management discussion and analysis

Auditor's report

Management report

Why is there demand for financial information?

User groups use it to direct capital flows to their most productive uses

Four basic financial statements

Balance sheet

Comprehensive Income

Cash flows

Shareholder's equity

What body is responsible for GAAP?

Financial Accounting Standards Board FASB

Economic entity

company keeps its activity separate from its owners and other businesses

User groups

Equity investors, debt investors, competitors, financial analysts, employees/labor unions, suppliers, customers, government

Parties involved in prep and use of financial information

Statement preparers, internal/external auditors, FASB and IASB, regulatory bodies, professional organizations

Reactive factors

Financial accounting reacts to pressure (politics and/or lobbying) and changes in its environment.

Proactive factors

financial accounting can influence its environment by providing feedback to users who reshape the economy

Who are standard setters and what do they do?

FASB (U.S.) and IASB (international) set rules and guidelines for financial reporting

Accounting Standards Codification

the single source of GAAP in the United States and includes all pronouncements issued by any of the standard-setting bodies that have not been superseded

FASB Standard Setting Process

1. Identification of problem

2. Decision to pursue

3. Public meetings

4. Exposure draft

5. Public roundtables

6. Redeliberation

7. Standard publication

International Accounting Standards Committee (IASC)

Set international accounting standards IAS until they were replaced by IASB, who introduced IFRS

3 trends in standard setting

Environmental

Social

Governance and Sustainability

Sustainability disclosures

Information about environmental, social, and governance factors related to company operations.

Significant influences on increased disclosure

Regulatory Developments

Role of technology (AI and machine learning)

Conceptual Framework

principles that ensure accounting standards are uniform-help develop and revise accounting standards

Conceptual framework components

Objective of Financial Reporting

Reporting Entity

Characteristics of quality financial info

Elements of financial reporting

Recognition and derecognition

Stewardship

Management's responsibility to the entity's economic resources

Fundamental Characteristics

Relevance and Faithful representation

Distinguish between useful and not useful info

Aspects of Relevance

Capability of making a difference in decision making via:

Predictive value (helps forecast future outcomes)

Confirmatory value (feedback about prior evaluation)

Materiality (would user decisions be different if this information were inaccurate or omitted)

Aspects of Faithful Representation

Is information presented in a way that depicts the substance of an economic event in a way that is:

Complete (all necessary info for users to understand it)

Neutral (free from bias)

Free from error (completely)

Four enhancing characteristics

Comparability

Verifiability

Timeliness

Understandability

Comparability

Ability to compare the accounting information of different companies because they use the same accounting principles.

Verifiability

occurs when independent measurers, using the same methods, obtain similar results

Timeliness

having information available to decision-makers before it loses its capacity to influence decisions

Understandability

Information presented in a clear and concise fashion so that users can interpret it and comprehend its meaning.

Cost Constraint

Weighs the cost that companies will incur to provide the information against the benefit that financial statement users will get from it

Point-in-time elements

Resources, claims to resources, or interests in resources as of a specific point in time - assets, liabilities, and equity, appear on the balance sheet

Period-of-time elements

represent the results of circumstances that affect an entity during a period of time and appear on the income statement, statement of comprehensive income, or statement of shareholders' equity

Period-of-time elements (cont.)

Investment by owners

Distribution to owners

Comprehensive income

Revenue

Expenses

Gains

Losses

Principles of accrual accounting

General recognition

Revenue and expense recognition

Recognition

The process of reporting an event as a line item in financial statements

3 criteria of recognition

Meets the definition of an element of financial statements

Measurable

Faithfully represented

Cost-Benefit Constraint

only information with benefits of disclosure greater than the costs of providing it need be disclosed

Materiality Threshold

Requires that an item be recognized in the financial statements if its inaccurate reporting would influence the judgment of statement user

Revenue Recognition Principle

The principle that companies recognize revenue when it is: Realized (a good is exchanged for cash or promise of cash)

Earned (service obligation has been fulfilled)

Five Steps of timing and measuring revenue

Identify contract with customers

Identify performance obligations of contract

Determine transaction price

Allocate price to performance obligations

Recognize revenue when obligations are satisfied

Expense Recognition Principles

Firms recognize expenses when they:

Consume assets/incur liabilities in the process of carrying out service obligations or other activities

Meet general recognition criteria

3 approaches to report an expense

Directly associate with revenues (ex. COGS)

Expense in period incurred (ex. salaries and wages expense)

Systemically allocate over period of use (ex. depreciation)

IFRS General Recognition Principles

Item is defined as an element

Item is measurable without high uncertainty

Item provides a faithful representation of the element

Item provides relevant information about the element

Income and Expense Recognition (IFRS)

Income is recognized when an asset increases or a liability decreases

Expenses are recognized when a liability increases or an asset decreases

Cash Basis Accounting

Reporting income when the cash is received and expenses when the cash is paid. (NOT GAAP COMPLIANT)

Accrual Accounting

accounting method that records revenues and expenses when the event occurs, not necessarily when cash actually changes hands

GAAP 5 Measurement Bases

Historical cost (what was paid to originally acquire the asset)

Current cost (to buy the same asset today)

Current market value (what you would get for selling the asset today)

Net realizable value (amount of cash received in exchange for an asset less cost of disposal)

Present value of future cash flows (discounting cash flows the firm expects to receive or pay on exchange or liquidation of an asset or liability)

Fair Value Hierarchy

Level 1: Price for the same asset/liability today

Level 2: Other measurable inputs, like valuing a building by price per square foot

Level 3: Unobservable inputs, like how much cash an investment is expected to generate

IFRS Derecognition

Removal of part or all of an asset/liability from the balance sheet if said element no longer meets the definition of an asset/liability

IFRS Measurement Bases

Historical Cost

Current Value

Current value

Fair Value

Value in use (present value of received cash flows - assets)

Fulfillment value (present value of paid cash flows - liabilities)

Current Cost

Notes to Financial Statements

Notes explain information presented in the financial statements regarding:

Line items

Reporting Entity

Events or conditions not in the statements which may affect cash flows

Capital Maintenance

How a company assesses changes in equity-

Financial Capital Maintenance

Physical Capital Maintenance

Financial Capital Maintenance

Capital is viewed as the financial amount, or money amount, invested in a company.

Physical Capital Maintenance

capital is viewed as the productive capacity of a company, such as units of output per day

Capital Maintenance Adjustments

Revaluations of reported amounts of assets and liabilities that companies don't report in net income

Assumptions in Financial Reporting

Going concern (the company will still exist tomorrow)

Economic entity (The owners and company are separate)

Monetary unit (Items are valued in currency terms)

Periodicity (company life is divided into artificial periods for reporting on economic activities, ex. quarterly)