MGA EXAM 1

SEC (Securities and Exchange Commision)

The U.S. government agency responsible for regulating the securities industry, enforcing federal securities laws, and protecting investors. It oversees securities exchanges, brokers, and dealers to ensure fair and efficient markets.

Financial Accounting Standards Board (FASB)

An independent organization that establishes financial accounting and reporting standards for companies and non-profit organizations in the U.S., enhancing transparency and consistency in financial reporting. Consists of 7 full-time members. In charge of accounting standards updates and financial accounting concepts.

Conceptual Framework

What is the objective of financial reporting?

The objective of financial reporting is to provide financial information about the reporting entity that is useful to investors, lenders, and other creditors in making decisions about providing resources to the entity.

Qualitative characteristics of accounting information (fundamental/primary)

relevance and representational faithfulness

Qualitative characteristics of accounting information (enhancing/secondary)

comparability, verifiability, timeliness, and understandability

Relevance

Information must be material, predictive value, and confirmatory value.

Representation faithful

Information must be complete, neutral, and free from error.

Measurement

the process of determining relevant numerical depiction of items recognized in financial statements

Negative consequence of Going Concern

If this assumption isn’t met, then listing assets and liabilities at anything other than net realizable value would not most relevant to decision makers.

Negative Consequence of Cost Constraint

Profits of the entity would be unnecessarily reduced or whipped out completely in attempt to be as detailed as possible for financial reporting purposes

Negative Consequence of Confirmatory Value

The financial statements would not be useful in evaluating prior expectations. For example, an investor would not be to assess if his/her decision to invest in an entity was a good or bad decision based on whether or not the company is performing as expected at the time of the investment decision

Negative Consequence of Materiality

If materiality is too high, useful information would be missing or buried in overly aggregated financial statements and disclosures. If materiality is too low, financial statement users could have to spend extra time analyzing the financial statements trying to determine first and foremost if the information presented is relevant or not. Additionally, financial reporting would be increasingly costly to capture and report more minute activity.

What does financial accounting try to capture and communicate? Who is it trying to communicate this to?

Broadly speaking, financial accounting is trying to capture and communicate the economic performance of an entity (like a company). It is trying to communicate this to capitalist who will make investing decisions

Why is the concept that “resources are scare” important to financial accounting?

There is insufficient capital and other resources to pursue all ideas, potential innovations, etc. Because of this, capitalists should be selective with how they invest their capital.

Who currently is responsible for establishing and maintaining U.S. Generally Accepted Accounting Principles? Where do they get this responsibility from?

The Financial Accounting Standards Board (FASB) currently has this responsibility. The Securities and Exchange Commission delegated this responsibility.

Why does the Financial Accounting Standards Board have a conceptual framework?

Broadly, it has the conceptual framework to help have a goal or target with its new pronouncements. More specifically: • Enables the FASB to issue more useful and consistent pronouncements over time • To solve new and emerging practical problem

Relevance Qualitative characteristics

predictive value, confirmatory value, materiality

Faithful representation Qualitative characteristics

completeness, neutrality, free from error

A company’s financial position is shown on the

balance sheet

a company’s financial performance is shown on the

income statement

external economic events

involve an exchange between the company and a separate economic entity (ex. purchasing inventory, obtaining financing from equity holders, and paying salaries to employees)

internal economic events

directly affect the financial position or performance of a company but do not involve an exchange transaction with another economic entity (ex. depreciation of equipment and the consumption of office supplies)

dual effect

fundamental accounting equation ( ASSETS= LIABILITIES+SE) portrays the basic identity of an entity and the equality between the total economic resources of a company and the total claims against it from both creditors and investors

shareholder’s equity component of the accounting equation can be classified by source:

amounts invested by shareholders or amounts earned by the company on behalf of shareholders, these amounts are presented in the balance sheet as paid-in capital (contributed capital) and retained earnings, respectively

double-entry structure

refers to the dual effect that each transaction has on the accounting equation

Journal entries record. activity,,,

to accounts within the general ledger

permanent accounts

in general, balance sheet accounts (ex. assets, liabilities, and equity) are permanent

temporary accounts

income statement accounts (ex. revenues expenses, gains, and losses) are temporary , show acitvity over a period of time (ex. a year)

Temporary accounts are periodic meaning…

usually closed (zeroed out) once a year and the net effect is recorded in the permanent retained earnings account, the following year must begin with a balance of zero

Common stock is

decreased by debits and increased by credits (credits is normal)

Dividends are

increased by debits (debits are normal) and decreased by credits

the accounting cycle

captures the process by which a company identifies, analyzes, records, and summarizes transactions in order to prepare financial statements, includes nine steps

Accounting steps DURING the accounting period

1) identify transaction and events to be recorded, 2) record transactions and events in a journal, 3) post from the journal to the ledger

Accounting steps AT THE END of the period

4) prepare an unadjusted trial balance, 5) identify, record, and post adjusting entries, 6) prepare an adjusted trial balance, 7) prepare financial statements

Accounting steps at the END OF THE FISCAL YEAR

8 ) prepare and post closing entries, 9) prepare a post-closing trial balance

a trial balance is

a list of the accounts along with their balances at a particular date

adjusted trial balance is

the balances in each account after all transactions both internal and external, are recorded during the period. This is the trial balance from which financial statements are prepated/ Prepared after recording adjusting entries.

purpose of the statement of cash flows

to report the events that caused cash to change during a period, displays the sources and uses of cash, and shows how balance sheet and income statement accounts affect a company’s cash

purpose of the statement of shareholder’s equity

is to document the changes in shareholder’s equity that result from transactions with owners, net income, and other comprehensive income

purpose of the statement of comprehensive income

is to report the changes in shareholder’s equity during the period that were not the result of transactions with owners. A few types of gains and losses- called other comprehensive income (OCI) are excluded from determination of net income but are included in the broader concept of comprehensive income

If expenses and losses exceed revenues and gains…

the company would debit retained earnings in the closing entry

What is an income statement?

A summary of an entity’s current operating performance for some period of time (ex one fiscal year)

Permanent accounts

assets liablitites and equity, found on balance sheet, carries over their values to next year

temporary accounts

investment by owners, distribution to owners, comprehensive income, revneues and gains, expenses and losses, bsaically all found on income statement and statemet of shareholders equity

Assumptions

economic entity, going conern, monetary unit, periodicity

Principles

measurement, revenue recognition, expense recognition, full disclosure

Gains

increases in equity (net assets) from peripheral or incidental transactions of an entity except those that result from revenues or investments by owners

Losses

decreases in equity (net assets) from peripheral or incidental transactions of an entity except those that result from expenses or distributions to owners

When do gains and losses occur?

gains and losses result form the sale of investments or plant assets, settlement of liabilities, and write-offs of assets due to impairments or casualty , generally result of investing activites

Income Statement limitations

companies omit items they cannot measure reliably, fair value measurements, “soft” assets are not recorded on the balance sheet, income is affected by the accounting methods employed, income measurement involves judgement,

Multi-step income statement

seperates and distinguishes operating transactions from non operating transactions, matches costs and expenses with related revenues, highlights certain compenents of income that analysts use assesing financial performance 1. operating section 2. nonoperating section 3 income tax

single-step income statement

simply revnues minus expenses, no seperation of operating vs nonoperating, and no implication that one type of revneue or expense item has priority over another, includes income tax in last section

Characteristics/ measures of high-quality earnings:

free of intentional or accidental error, earnings are a faithful representation of the true economic and financial performance of the entity, revenues and expenses recorded in accordance with GAAP, earnings is a good predictor of future cash flows

What are unusual items?

the underlying event or transaction should posses a high degree of abnormality and of a type clearly unrelated to, or only incidentally related to, the ordinary and typical acitvities of the entity, taking into account the environment in which the entity operates

What are infrequent items?

The underlying event or transaction should be a type that would not reasonably expected to recur in the foreseeable future, taking into account the environment in which the entity operates.

Common types of unsual or infrequent gains and losses

losses on write-down (impairment) of receivables; inventories; property, plant, and equipment; goodwill or other intangible assets, restructing charges, gains and losses from sale or abandonment of property, plant and equipment, effects of a strike, gains and losses on extinguishment (redemption) of debt oblifations, gains and losses related to casualities such as fire, floods, and earthquakes, gains or losses on sale of investment securities, THESE MUST BE PRESENTED AS A SEPARATE COMPONENT OF INCOME FROM CONTINUING OPERATIONS

What are discontinued operations?

•Sometimes a company will decide to sale or dispose a major component of its business

•The disposal is classified as discontinued operations when:

1.A component of a business is held for sale, sold, or otherwise disposed

2.The disposal represents a strategic shift for the company, having a major effect on the company’s operations and financial results

•Discontinued operations, less applicable income taxes (i.e., after tax), are reported as a separate component of income

The most commonly reported per share item is earnings (ex, net income), the formula for earnings per share (EPS) is :

net income- preferred dividends / weighted average of common shares outstanding

What is non-controlling interest?

the portion of equity (net assets) interest in a subsidary not attributable to the parent company, net income must be allocated to the controlling and non-controlling interest

What is comprehensive income?

represents all changes in shareholder’s equity that occur during a period except those resulting from investment by and distribution to owners. CI includes all revenus, expenses, gains, and losses from the IS. CI also includes a small set of other gains and losses that bypass the income statement but still affect shareholders’ equity; the summary effect of these items is referred to as other comprehensive income (OCI), THEREFORE CI= NI+OCI

Comprehensive Income (single-statement approach)

a single continues statement where both net income and other compreheensive income are disclosed in a single document. Advantage: does not require the creation of another financial statement. Disadvantage: net income is buried as a subtotal on the statement rather than being prominently featured as the bottom line

Comprehensive Income (two-statement approach)

two separate, but consecutive statements of net income and OCI, Advantage:

Usefulness of the Balance Sheet

helps assess a company’s capital structure, which is relative use of debt vs equity to finance the company’s operations

liquidity

refers to a companys ability to pay its short term obligations

solvency

refers to a company’s ability to meet its long-term fixed costs and achieve lasting expansion and growth

fair market value

the value of a cpmpany;s recorded and unrecorded assets and liablities taken together, and is generally represetned by a company’s market capitalization, which is the total value of its outstanding shares of stock

Net Book Value (Net assets)

its assets minus liablities according to GAAP- will not perfectly capture a company’s fair market value or liquidation value , NBV can help users assess a company’s fair market value or liquidation value

liquidation value - BS limitation

the BS does not portray the liquidation value of the company, the value its assets would fetch if they were quickly sold in an orderly market, liquidation value deos not typically include any intangible assets, we generally assume that lqiuidation value approximates a companys worth if it filed ofr bakruptcy

Classified balance Sheet

when assets and liabilities are classfied by liquidity, the BS is called a classified BS , allows for the calculation of a company;s net working capital (NWC) which is the excess (or shortage) of current assets over current liablities: NWC= CA - CL

cash realization

begins with the cash purchase of raw materials and ends with the colelction of cash from the sale of finsihed goods

Goodwill

is an intagible asset that results when a company purchases another company, represents premium paid, is not amortized because it is considered to have an indefinite life

paid-in-capital

represents the amounts invested by shareholders , reflects the resources (usually cash) invested by shareholders i n exchange for ownership interests

retained earnings

represents thte amounts earned by the company on behald of shareholders , is the accumulation of a company;s net income (loss) less distributions to shareholders since its inception, in effect, retained earnings represtns the amount that can be paid to investors as future dividends

Accumulated Other Comprehensive Income

is the permanent account that items within OCI are close to, dividends are not paid from AOCI, instead, balance are removed from AOCI when the unrealized gains and losses become realized, at which point, they are presented within net income

disclosure notes

provide additional details through narrative descriptions

supporting schedules

used to provide additonal breakdown of balances that do not fit in the base financial statements

parenthetical notes

bried notes on the base financial statements

Note #1

Disclosure of the accounting policies followed by the entity and the methods of applying principles, this note is heavily focused on principles and methods of apply principles with the little disclosure of values or balances

Uses of fair value hierarch

level 1: quoted prices in active markets for identical assets (ex. share of a publicly traded company), level 2: significant other observable inputs (ex. agency issued mortgage-backed security), level 3: significant unobservable inputs (ex. investment in a private company)

related party transacations

summary disclosure of transactions made with related parties

subsequent events

summary of events or transactions that occur after the balance sheet date but before financial statements are issued or are available to be issued

Form S-1

Initial registration statement for a public offering which includes Part 1 (prospectus that is delivered to those interested in purchasing the shares) and Part 2 (additonal information that must be filed with the SEC)

Form 10-k

Overview of a company;s business and financial condition, including audited financial statements, filed annually at the comapny’s fiscal year-end

Form 10-Q

Report including unaudited financial statements filed quarterly for the first three quarters of a fiscal year

Form 20-F and form 40-F

Annual financial reports filed by certian Canadian companie and other non- U.S registrants (20-f)

Auditors Report

an opinion from the company’s audtiros on whether the financial statemtens are presented fairly in accordance with GAAP, only allows filing containing an unqualified opinion,

What is the purpose of the statement of cash flows?

To provide information about cash receipts (inflows) and cash disbursements (outflows) that occurred during a period, this rfers to the term CASH AND CASH EQUIVALENTS

The statement of cash flows reconciles…

a company’s cash balance from the beginning of the period to its cash balance at the end of the period

Net cash flows from operating activities are particularly important because…

• companies need to convert their profits into cash flows

• allows users to compute a measure of earnings quality

operating activities

• involves producing, providing, and delivering goods and services to customers

• reflect the inflows and outflows of cash that result from activites reported in the income statement

• is a residual category

• net oprating cash flows is teh cash-basis analogue of net income

examples of operating cash flows include:

cash received from customers, interest received, dividends received, insurance proceeds and lawsuit settlements, sales of short-term investments, purcahse of short-term investments, cash paid to suppliers and employees, payment of interest on amount borrowed, income taxes paid, normally would find these in current assets and current liabilitties

investing activities

involves the purchase and sale of long-term assets used in the operations of the business and nonoperating investment assets

examples of investing activities

making loans to other entities and then collecting principal repayments, purchasing or selling securities in other entities not classified as short-term, purcahsing or selling property, plant, and equipment or intangible assets,

• the purchase and sale of inventories are not considered investing activities

• investing activities are related to a company’'s noncurrent assets

financing activities

• are cash inflows and outflows from transactions with investors (owners) and creditors (excluding trade creditors)

• relate to a company’s external financing, which is how the company raises cash outside of its operations

• related to a company’s noncurrent liabilities and equity

common financing activities include:

• obtaining resources from owners, such as issuing stock

• providing owners with a return on their investment such as paying dividends or repurchasing stock

• obtaining resources from creditors, such as issuing bonds, notes, and other borrowings

• payment of principal amount borrowed

• NOTE: THE PAYMENT OF PRINCIPAL IS A FINANCING ACTIVITY WHILE THE PAYMENT OF INTEREST IS AN OPERATING ACTIVITY

Noncash Investing & Financing activities examples:

• the purchase of fixed assets by issuing shares of stock

• the conversion of bonds to equity (ex. shares of preferred stock)

• acquiring assets through the incurrence of a lease obligation or the signing of a mortgage

• the exchange of one noncash asset for another noncash asset (ex. swapping equipment with another company)

These transactions do not involve the exchange of cash, but they are likely material events for the company

Statement of Cash Flows: indirect Method

• start with reported net income (loss) and working backwards to convert that amount to a cash basis

• indirect method is essentially a conversion from accrual-basis accounting (net income) to cash-basis accounting (net operating cash flows)

• start with net income, remove the effect of noncash expenses and transactions, and analyze the change in working capital accounts (ex. current assets and liabilities)

• First, eliminate noncash expenses by adding depreciation, amortization, and depletion

• second, eliminate the effect of noncash transactions by subtracting gains and adding losses (typically investing activites)

• Finally, subtract changes in current assets, and add changes in current liabilities

Statement of cash flows: Direct Method

• cash effect of each operating activity is reported directly in the statement

• ex. cash receipts from customers is reported as the cash effect of sales transactions and cash disbursed to suppliers is the cash effect of purchasing inventory (the summation of these items represents net operating cash flows)

Statement of Cash Flows Presentation

• cash flows from investing and financing activities are always presented using the direct method

• beginning and ending cash and cash equivalents are also shown

• cash flows for the period details the change between the two

• beginning and ending balances need to tie to the balance sheet