Chapter 1 (Environment & Theoretical Structure of Financial Accounting) – Flashcards
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Providing relevant financial information to various external users
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What is Financial Accounting concerned with?
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1. Financial Analysts 2. Stockbrokers 3. Mutual Fund Managers 4. Credit Organizations
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Who are Financial Intermediaries
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1. The Balance Sheet 2. The Income Statement 3. The Statement of Cash Flows 4. The Statement of Shareholders' Equity
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What are the most frequently provided financial statements?
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Provide a mechanism to help our economy allocate resources efficiently
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What do Capital markets do?
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All investors and creditors
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Who is composed in Capital Markets?
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When a corporation sells shares of stock or bonds to individuals or other entities that want to invest in the corporation
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What are initial market transactions?
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Transfer of stocks and bonds between investors and creditors (corporations receive no new cash form these transactions)
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What are secondary market transactions?
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The money the investor makes from a stock, it is calculated by: (dividends + share price application) divided by the initial investment cost
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What is the rate of return and how is it calculated?
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A major accounting method that recognizes revenues and expenses at the time physical cash is actually received or paid out.
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What is Cash Basis Accounting ?
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produced by cash basis accounting, it is the difference between cash receipts and cash disbursements from providing goods and services
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What is the Net Operating Cash Flow?
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An accounting method that measures the performance and position of a company by recognizing economic events regardless of when cash transactions occur.
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What is Accrual Accounting?
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produced by accrual accounting, it is the difference between revenues and expenses
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What is Net Income?
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Net Income is better than current net operating cash flow
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What is considered a better indicator of future operating cash flows
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The Generally Accepted Accounting Principles, the body of standards that the financial accounting community must follow
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What is GAAP?
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It is the Securities and Exchange Commission, They set accounting and reporting standards for companies whose securities are publicly traded (Created in 1934 by the Securities Exchange Act)
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What is the SEC?
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The original private sector body that was created to set accounting standards (Committee on Accounting Procedures)
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What is the CAP?
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American Institute of Certified Public Accountants, the national professional organization for certified professional pubic accountants
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What is the AICPA?
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The Accounting Principles Board, replaced the CAP, operated from 1959-1973, and issued 31 Accounting Principles Board Opinions (APBO's)
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What is the APB?
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The Financial Accounting Standards Board, Replaced the APB in 1973 and is still in use. Has 7 full time members
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What is the FASB?
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The Emerging Issues Task Force, was formed to improve financial reporting by resolving narrowly defined financial accounting issues within the framework of existing GAAP
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What is the EITF?
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The International Accounting Standards Committee, formed in 1973 to develop global accounting standards and renamed the ISAB in 2001. Their main goal is to create a single set of high-quality, understandable, and enforceable global accounting standards to help participants in the world's capital markets.
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What is the IASC?
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They serve as an independent intermediary to help ensure that management has in fact appropriately applied GAAP in preparing the company's financial statements.
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What does an Auditor do?
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Certified Public Accountants which are licensed by each state to provide auditing services
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What is a CPA?
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It applies to public securities-issuing entities. It provides for the regulation of auditors and the types of services they furnish to clients, increases accountability of corporate executives, addresses conflicts of interest for securities analysts, and provides for stiff criminal penalties for violators
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What is the Sarbanes-Oxley Act?
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1. Principles-Based (Objectives-Oriented) 2. Rules-Based
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2 types of accounting standards
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Emphasizes using professional judgement, as opposed to following a list of rules, when choosing how to account for a transaction
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Principles-Based Accounting Standards
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Follows a list of rules when choosing how to account for a transaction
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Rules-Based Accounting Standards
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It deals with the ability to distinguish right from wrong
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What is Ethics
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It provides the underlying foundation of U.S. accounting standards (Like the U.S. Constitution is the foundation for the laws of our land)
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What is the Conceptual Framework?
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The qualities of relevance and faithful representation
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What must information possess to be useful for decision making?
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That The information must possess predictive value and/or confirmatory value
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What does relevance in the context of financial reporting mean?
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If omitting it or mistaking it could affect users' decisions (GAAP does not need to be followed if a item is immaterial)
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When is financial information considered material?
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When there is agreement between a measure or description and the phenomenon it purports to represent
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When does faithful representation exist?
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it requires that information be complete, neutral, and free from error.
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What does faithful representation require?
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1. Comparability 2. Verifiability 3. Timeliness 4. Understandability
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What are four enhancing qualitative characteristics?
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When it is measured and reported the same way in each time period
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When is accounting information considered consistent?
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it should be comparable across different companies and over different time periods
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How should accounting information be comparable?
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If different measures would reach consensus about whether it is representationally faithful
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When is accounting information considered verifiable?
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If it is available to users before a decision is made
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When is accounting information considered Timely?
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If users can comprehend it
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When is accounting information considered understandable?
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Only if the benefit of increased decision usefulness exceeds the costs of providing that information
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When is information cost effective?
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1. Assets 2. Liabilities 3. Equity (Net Assets) 4. Investments by owners 5. Distributions to owners 6. Comprehensive Income 7. Revenues 8. Expenses 9. Gains 10. Losses (for definitions see pg. 25)
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What are the 10 elements of Financial Statements?
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1. The economic entity assumption 2. The going concern assumption 3. The periodicity assumption 4. The monetary unit assumption
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What are the 4 basic assumptions that underline GAAP?
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It presumes that economic events can be identified specifically with an economic entity
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What does the economic entity assumption presume?
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In the absence of information to the contrary, we anticipate that business entity will continue to operate indefinitely
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What is the going concern assumption?
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It allows the life of a company to be divided into artificial time periods to provide timely information
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What does the periodicity assumption allow?
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The 12-month period that ends when the business activities of a company reach their lowest point in the annual cycle
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What is a natural business year?
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It states that financial statements elements should be measured in a particular monetary unit (In the U.S it is the dollar)
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What does the monetary unit assumption state?
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the process of admitting information into the financial statements
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What does recognition refer do?
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The process of associating numerical amounts with the elements
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What is Measurement ?
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the process of including additional pertinent information in the financial statements and accompanying notes
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What does Disclosure refer to?
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1. The item meets the definition of an element of financial statements 2. The item has a relevant attribute measurable with sufficient reliability 3. The information about it is capable of making a difference in user decisions 4. The information is representationally faithful, verifiable, and neutral
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What is the general recognition criteria?
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1. The earnings process is judged to be complete or virtually complete 2. There is reasonable certainty as to the collectability of the assets to be received (usually cash)
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What two criteria should be satisfied before revenue can be recognized according to the realization principle?
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the primary earnings activity that triggers the recognition of revenue
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What is the critical event?
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That expenses be recognized in the period in which they produce revenues
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What does the matching principle require?
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1. Based on an exact cause-and-effect relationship 2. By associating an expense with the revenues recognized in a specific time period 3. By a systematic and rational allocation to specific time periods 4. In the period incurred, without regard to related revenues (for more information, view pg. 28)
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What are the 4 different approaches for expense recognition?
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1. Historical costs 2. Net realizable value 3. Current cost 4. Present value of future cash flows 5. Fair value
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What are the 5 measurement attributes employed by GAAP?
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It should be the one that maximizes the combination of relevance and it should represent faithfulness
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How should the measurement attribute be chosen?
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The amount given or received in the exchange transactions
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What does historical costs base its measurements from?
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The amount of cash into which the asset or liability will be converted in the ordinary course of business
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What does net realizable value base its measurements from?
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The amount of cash needed to purchase or reproduce the goods
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What does current cost base its measurements from?
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On future cash flows discounted for the time value of money
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What does present value base its measurements from?
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from the price that would be received to sell assets or transfer liabilities in an ordinary market transaction
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What does fair value base its measurements from?
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1. Market approaches 2. Income approaches 3. Cost approaches
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How can fair value be measured?
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It requires that any information useful to decision makers be provided in the financial statements, subject to the cost effectiveness constant
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What does the full disclosure principle require?
