Financial Accounting & Standards-Setting Overview

These question-and-answer flashcards cover the key definitions, organizational structures, standard-setting processes, conceptual framework components, qualitative characteristics, elements, recognition, measurement bases, and current trends highlighted in the lecture notes on financial accounting.

What is the definition of financial accounting?

The process of identifying, measuring, and communicating financial information about an economic entity to various user groups within its environment.

Financial accounting is synonymous with what other term?

Financial reporting.

What is the primary goal of accounting (aka "language of business"?)

To communicate the financial position and financial performance of a company.

Name four primary financial statements found in an annual report.

Comprehensive income statement, balance sheet (statement of financial position), shareholders’ equity statement, and cash-flow statement.

Give two examples of disclosures that accompany financial statements.

Notes to the financial statements and the auditor’s report (others include MD&A, financial summary, press releases, etc.).

Define an economic entity in accounting.

An organization or unit whose activities are separate from those of its owners and from other entities (e.g., a corporation, partnership, sole proprietorship, or governmental unit).

List three user groups of financial statements classified as capital providers.

Equity investors, debt investors (bondholders), and creditors (banks and other lending institutions).

Who prepares financial information inside a firm’s managerial accounting function?

Preparers—the users and preparers are the same in managerial accounting.

What U.S. regulatory body oversees publicly traded companies?

The Securities and Exchange Commission (SEC).

Which body oversees the audits of public companies in the United States?

Public Company Accounting Oversight Board (PCAOB).

What set of accounting rules is promulgated by the FASB?

U.S. GAAP (Generally Accepted Accounting Principles).

What set of global accounting rules is issued by the IASB?

IFRS (International Financial Reporting Standards).

Why must many U.S. accountants understand IFRS?

Because U.S. companies have foreign subsidiaries using IFRS, foreign companies list in the U.S. with IFRS reports, and many U.S. accountants work abroad.

Identify the three main organizations within the FASB’s oversight structure.

FAF (Financial Accounting Foundation), FASAC (Financial Accounting Standards Advisory Council), and EITF (Emerging Issues Task Force).

What governmental accounting body parallels the FASB?

GASB (Governmental Accounting Standards Board).

In FASB standard setting, what document solicits public input before a standard is finalized?

An Exposure Draft (ED).

What is the final authoritative document issued by the FASB that updates GAAP?

An Accounting Standards Update (ASU).

Which committee within the IASB structure functions like the U.S. EITF?

The IFRS Interpretations Committee.

Name the three major trends in standards setting highlighted in the lecture.

1) Principles-based vs. rules-based standards, 2) Asset/liability approach, and 3) Fair-value accounting.

Describe a pure principles-based standard.

It provides a clear accounting objective tied to a conceptual framework, contains few exceptions, avoids bright-line tests, offers minimal implementation guidance, and requires significant professional judgment.

Give one problem associated with pure principles-based standards.

Comparability across entities can suffer because of extensive preparer judgment.

Describe a pure rules-based standard.

It relies heavily on detailed rules, includes numerous exceptions and bright-line tests, provides extensive application guidance, and requires little professional judgment.

Name one problem caused by rules-based standards.

Financial engineering that circumvents the intent of standards, reducing transparency.

What is an objectives-oriented standard according to the SEC?

A hybrid approach relying on a strong conceptual framework, minimal exceptions, limited bright-line tests, and some managerial judgment.

Differentiate the income-statement approach from the asset/liability approach.

The income-statement approach records events based on revenue recognition or matching, whereas the asset/liability approach records events based on whether they meet asset or liability definitions.

Define fair value in accounting.

The amount at which an asset or liability can be bought or sold in a current transaction between willing parties.

What overarching document guides both the FASB and IASB in developing coherent standards?

The Conceptual Framework.

State the primary objective of financial reporting according to the Conceptual Framework.

To provide financial information useful to existing and potential investors, lenders, and other creditors in making resource-allocation decisions.

Name the two fundamental qualitative characteristics of useful financial information.

Relevance and faithful representation.

List the three attributes that make information relevant.

Predictive value, confirmatory value, and materiality.

List the three attributes of faithful representation.

Completeness, neutrality, and freedom from error.

Identify four enhancing qualitative characteristics.

Comparability, verifiability, timeliness, and understandability.

What constraint balances the provision of information with practicality?

The cost constraint—benefits of information must outweigh its costs.

Define the point-in-time element 'asset' under U.S. GAAP.

Probable future economic benefits obtained or controlled by an entity as a result of past transactions or events.

Define the point-in-time element 'liability' under U.S. GAAP.

Probable future sacrifices of economic benefits arising from present obligations to transfer assets or provide services as a result of past transactions or events.

What is equity under U.S. GAAP?

The residual interest in the assets of an entity after deducting liabilities (net assets).

Distinguish revenues from gains.

Revenues arise from a company’s ongoing major operations; gains arise from peripheral or incidental transactions.

Distinguish expenses from losses.

Expenses relate to ongoing major operations; losses result from peripheral or incidental transactions or events.

Under IFRS, what element combines revenues and gains?

Income.

What is recognition in financial reporting?

The process of including an economic event as a line item in the financial statements rather than only in the notes.

List the four general recognition criteria under U.S. GAAP.

1) Meets definition of an element, 2) Measurable, 3) Reliable, and 4) Relevant (benefits exceed costs).

Under IFRS, what replaces "relevance" in the fourth recognition criterion?

Probability that future economic benefits will flow to or from the company.

State the revenue recognition principle under U.S. GAAP.

Recognize revenue when it is realized or realizable and earned.

When is revenue realized versus realizable?

Realized when cash or fixed claims to cash are received; realizable when the company receives the right to bill and expects payment.

Name the three main approaches to expense recognition under U.S. GAAP.

Match with revenues, expense in period incurred, and systematic allocation (e.g., depreciation).

List the five measurement bases allowed under U.S. GAAP.

Historical cost, current cost, current market value, net realizable value, and present value of future cash flows.

Which measurement base is omitted in IFRS compared with U.S. GAAP?

Current market value (IFRS treats current cost, NRV, and present value as measures of current market value).

Describe Level 1 inputs in the fair-value hierarchy.

Quoted prices in active markets for an identical asset or liability (e.g., publicly traded equity security).

Provide an example of Level 2 inputs.

Valuing a building using price-per-square-foot data from recent transactions in comparable properties.

What characterizes Level 3 inputs?

Unobservable inputs such as discounted cash-flow models for private equity valuations.

Explain the purpose of the FAF (Financial Accounting Foundation).

It provides oversight, administration, and funding for the FASB.

What is the main advisory body to the FASB called, and who serves on it?

FASAC (Financial Accounting Standards Advisory Council) composed of analysts, preparers, auditors, and academics.

State two advantages of convergence between GAAP and IFRS.

Enhances comparability for global investors and reduces the need for duplicative reporting by multinational companies.

What is financial engineering, and why is it a concern with rules-based standards?

Designing transactions to meet specific rules while undermining the standard’s intent, reducing transparency.

Which 2003 report endorsed objectives-oriented standards as optimal?

A report issued by the U.S. SEC (Securities and Exchange Commission).