Intermediate Accounting Exam 1

Net Income

Revenues plus gains less expenses and losses

Goal of financial reporting

Provide useful information to capital providers

FASB statements of financial accounting concepts

Identify the conceptual framework within which accounting standards are developed

Revenue is recognized when

A good or service has been delivered to a customer

In depreciating the cost of an asset, what are accountants most concerned about?

Recognizing the expense in the appropriate period

The primary objective of expense recognition is to:

Record expenses in the period that related revenues are recognized

Fundamental qualitative characteristics:

Relevance and faithful representation

Relevance

Has the potential to affect a decision. Must possess predictive value and/or confirmatory value

Faithful representation

Exists when there is an agreement between a measure and the real world phenomenon it purports to represent. Must be complete, neutral, and free from error.

Enhancing qualitative characteristics

Comparable, consistent, verifiable, timely, understandable

Cost effectiveness

The benefit of increased decision usefulness exceeds the costs of providing that information

Underlying assumptions

Economic entity, going concern, periodicity, and monetary unit

Economic entity assumption

All economic events can be identified with a particular economic entity

Going concern

Anticipated that a business will continue to operate indefinitely

Periodicity

The life of a company can be divided into artificial time periods to provide timely information to users

Monetary unit

In the U.S, statement elements should be measured in terms of the U.S dollar

Recognition

Process of admitting information into financial statements. Must include definition, measurability, and faithful representation.

Measurement

5 attributed employed in GAAP: historical cost, net realizable value, current cost, present value of future cash flows, fair value.

Disclosure

Financial reports should include all information that could affect decision making by external users (parenthetical amounts, notes to financial statements, supplemental tables…)

Expanded accounting equation

Assets = liabilities + paid-in capital + retained earnings

Debits

Dividends, expenses, and assets

Credits

Liabilities, equity, and revenue

Adjusting entries

Necessary for prepayments, accruals, and estimates

Shareholders’ equity

Common stock + retained earnings

Current assets

Cash, short term investments, accounts receivable, inventory, prepaid expenses

Inventory

Raw materials, WIP, finished goods

Long term assets

Property, planet and equipment, intangible assets (patents, copyrights, licenses), long-term investments

Current liabilities

Accounts payable, short-term notes payable, current portion of long term debt, accrued liabilities/expenses, deferred revenue

Balance sheet

Lists assets, liabilities, and shareholders’ equity

Balance sheet format

Current assets in descending liquidity, then long-term assets, total assets, current liabilities in order of maturity, long term liabilities, total liabilities, equity, total liabilities + equity

Retained earnings

Ending R.E = Beginning R.E + net income - dividends

Common stock

number of shares issued x par value per share

Order of financial statements

Income statement → statement of retained earnings → balance sheet → cash flows statement

Gross profit

Sales revenue - cost of goods sold

Operating items

include revenues, expenses, gains, and losses directly related to the primary revenue generating activities of a company

Non-operating items

Include certain revenues, expenses, gains and losses from peripheral activities

Comprehensive income

Total non-owner changes in equity for the period. Equal to net income + other comprehensive income. Reported either in a continuous single step or multi step consecutive statements

Statement of cash flows

Summarizes the transactions that caused cash to change during a period. Includes operating, investing, and financing activities.

Operating activities

Revenues and expenses involved in running a business. Includes inflows of cash received from customers for sales, interest received on loans, and dividends received from investing in other companies. Includes outflows of cash paid to suppliers, wages paid to employees, cash paid for operational expenses, and income taxes paid to government

Investing activities

Cash flows resulting from the acquisition and disposal of long term assets and investments in other entities. Shows how much capital the company is investing in future growth. Cash inflows include cash received from sales of PPE, cash from sale of intangibles, cash from selling stocks, and collection of principal on loans made to other entities. Cash outflows include cash paid to purchase PPE, cash paid to purchase intangibles, cash paid to purchase investment securities.

Financing activities

Cash flows between company and its owners; shows how the business finances their operations and growth. Cash inflows include cash from issuing stock and cash received from issuing long term bonds or notes payable. Cash outflows include cash paid to purchase own stock, cash dividends paid to shareholders, and principal payments on long term loans

Limitations of balance sheet

Uses historical cost rather than current market value, snapshot in time, and ignores inflation

Assets

Present rights of an entity to an economic benefit

Liabilities

Present obligation of an entity to transfer an economic benefit

Equity

Represents the residual interest in the assets of an entity that remains after deducting its liabilities

Subsequent event

A significant development that takes place after a company’s fiscal year-end but before the financial statements are issued

Deferrals

Occurs when cash is exchanged before related revenue or expense is recognized. Deferred expenses such as prepaid rent or insurance are current assets, while unearned revenues or other items collected in advance are current liabilities

Accruals

Occurs when a revenue or expense is recognized before cash is exchanged. Accrued revenues include accrued interest earned on investments, services completed on credit, and unbilled wip and are listed as assets. Accrued expenses are liabilities and include unpaid bills, accrued interest on loans, and unpaid property taxes

Income statement

Follows the basic formula: Net income = revenues - expenses + gains -losses

Single step income statement

Groups all revenues and gains together and all expenses and losses together. Does not solve for gross profit or distinguish operating income fron non-operational income

Multi-step income statement

Separates operational and non-operational activities. Need to solve for gross profit (sales-COGS), operating income (gross profit-operating expenses), income before taxes (operating income + non-operating items) and then net income (income before taxes-income tax expense)

Non-operating revenues and expenses

Comes after operational expenses in a multi-step income statement. Includes interest, gains/losses on sales of PPE and investments, foreign currency translation gains/losses, and peripheral items (impairment losses, insurance recoveries, etc.)