Intermediate Accounting Study Notes

Intermediate Accounting

Dr. Mohammed Salama

Course Content

• Ch. 1: Theoretical Framework

• Ch. 2: Statement of Cash Flows

• Ch. 3: Accounting for Inventory

• Ch. 4: Accounting for Plant Assets

• Ch. 5: Accounting for Intangible Assets

• Ch. 6: Corporations: Capital Stock Transactions

• Ch. 7: Corporations: Dividends

• Ch. 8: Corporations: Long-Term Liabilities

/

/

/

/

/

Chapter One: The Theoretical Framework of Financial Accounting

Chapter Contents

1. Objectives of Preparing Financial Statements

2. Qualitative Characteristics of Accounting Information

3. Basic Elements of Financial Statements

4. Accounting Assumptions and Principles

5. Financial Statements and Financial Reporting

Financial Statements

• Financial statements are the most important tool for communicating financial information to external parties.

• The financial statements include:

  1. Balance Sheet

  2. Income Statement

  3. Statement of Comprehensive Income

  4. Statement of Cash Flows

  5. Statement of Equity

  6. Notes to the Financial Statements

Objectives of Financial Statements

• The preparation of financial statements aims to:

  1. Provide useful information for investment decisions.

  2. Provide useful information to current and prospective investors, creditors, and others about the amount, timing, and degree of uncertainty associated with expected cash flows.

  3. Provide information about an entity's resources (assets) and the claims (liabilities) related to these resources.

Qualitative Characteristics of Accounting Information

• These characteristics can be divided into two groups:

  1. Primary Characteristics

  2. Secondary Characteristics

Primary Characteristics

1. Relevance

   • Information must meet the user's needs and influence their decisions.

   • Sub-characteristics of relevance include:

   1. Predictive Value: Enables the user to predict future events.

   2. Confirmatory Value: Enables the user to verify the accuracy of previous predictions.

   3. Timeliness: Information must be provided in a timely manner.

2. Faithful Representation

   • For accounting information to be presented faithfully, it must possess three essential sub-characteristics:

   1. Complete: Must include all information necessary for a user to understand it.

   2. Neutral: No bias in the selection or presentation of financial information.

   3. Free from Error: Information must be accurate and reliable.

Secondary Characteristics

1. Understandability

   • The information must be understandable to users with a reasonable level of accounting knowledge.

2. Comparability

   • Information must allow for comparison from one year to another for the same firm and with similar firms conducting the same activity.

3. Verifiability

   • Achieved when there is a high degree of agreement among individuals using the same measurement method. Example: Several independent auditors might reach the same conclusion regarding a number of financial statements.

4. Timeliness

   • The sooner information is available, the more useful it is.

The Basic Elements of Financial Statements

1. Assets:

   • Potential future economic benefits that an entity has acquired.

2. Liabilities:

   • Potential future sacrifices of economic benefits.

3. Equity:

   • The remaining assets of a particular entity after deducting its liabilities.

4. Owners' Investments:

   • Increases in a company's net assets resulting from the owners.

5. Dividends:

   • Decrease in a company's net assets resulting from the company transferring assets to its owners, thus reducing the entity's equity.

6. Revenues:

   • Inflows or increases in an entity's assets during a specific period, resulting from the provision or production of goods or services.

7. Expenses:

   • Outflows or decreases in assets during a specific period, resulting from the acquisition or production of goods or services.

8. Comprehensive Income:

   • Change in an entity's equity (net assets) during a specific period resulting from transactions not related to the owners.

9. Gains:

   • Increase in equity (net assets) resulting from extraordinary transactions excluding those resulting from revenues and owners' investments.

10. Losses:

    • Decrease in equity (net assets) resulting from extraordinary transactions excluding those resulting from expenses or dividends.

Accounting Assumptions

1. Economic Entity Assumption:

   • States that the business has a legal personality separate from its owners. Therefore, the business's transactions must be kept separate from the transactions of its owners.

2. Going Concern Assumption:

   • Assumes that a business is established to continue operating for a period of time until it achieves its objectives.

3. Monetary Unit Assumption:

   • States that all recorded transactions are expressed in monetary terms.

4. Periodicity Assumption:

   • Indicates that the economic activities of the firm can be divided into time periods (month/quarter/half year/year) for accurately measuring the results of the firm’s work. The year is the most common time period for reporting.

Accounting Principles

1. Historical Cost Principle:

   • What is recorded in the books is based on its purchase price and remains recorded at that price until disposed. Current accounting principles require most assets and liabilities to be reported based on their acquisition price.

2. Revenue Recognition Principle:

   • Refers to the point in time at which revenue is recorded in the entity's books. Revenue is realized when goods or services are exchanged for cash or cash claims.

3. Matching Principle:

   • Revenues of the period are matched with expenses to determine profit or loss.

4. Full Disclosure Principle:

   • Accountants must provide sufficient information relevant to users and ensure that the information is understandable.