Intermediate Accounting Chapter 1 – Flashcards

question
What is the function and primary focus of financial accounting?
answer
- Providing *relevant financial information* about various kinds of organizations to different types of external users - The primary focus of financial accounting is on the financial information provided by profit-oriented companies to their present and potential investors and creditors
question
What is meant by the phrase "efficient allocation of resources"? What mechanism fosters the efficient allocation of resources in the United States?
answer
Resources are efficiently allocated if they are given to enterprises that will use them to provide goods and services desired by society and not to enterprises that will waste them. The *capital markets* are the mechanism that fosters this efficient allocation of resources
question
Identify two important variables to be considered when making an investment decision.
answer
- expected rate of return - uncertainty or risk of that expected return
question
What must a company do in the long run to be able to provide a return to investors and creditors?
answer
In the long run, a company will be able to provide investors and creditors with a rate of return only if it can generate a profit. That is, it must be able to use the resources provided to it to generate cash receipts from selling a product or service that exceed the cash disbursements necessary to provide that product or service.
question
What is the primary objective of financial accounting?
answer
provide *investors and creditors* with information that will help them make *investment and credit* decisions
question
Define net operating cash flows. Briefly explain why periodic net operating cash flows may not be a good indicator of future operating cash flows.
answer
Net operating cash flows are the difference between cash receipts and cash disbursements during a period of time from transactions related to providing goods and services to customers. Net operating cash flows may not be a good indicator of future cash flows because, by ignoring uncompleted transactions, they may not match the accomplishments and sacrifices of the period.
question
What is meant by GAAP? Why should all companies follow GAAP in reporting to external users?
answer
- GAAP (generally accepted accounting principles) are a dynamic set of both broad and specific guidelines that a company should follow in measuring and reporting the information in their financial statements and related notes - It is important that all companies follow GAAP so that investors can *compare financial information across companies* to make their resource allocation decisions
question
Explain the roles of the SEC and the FASB in the setting of accounting standards.
answer
Congress --> SEC --> sets accounting and reporting standards for publicly traded companies SEC (retained power)--> (delegated to) FASB --> responsible for setting accounting standards In 1934, Congress created the SEC and gave it the job of *setting accounting and reporting standards* for companies whose securities are publicly traded. The SEC has retained the power, but has delegated the task to private sector bodies. The current private sector body responsible for setting accounting standards is the FASB.
question
Explain the role of the auditor in the financial reporting process.
answer
Auditors are independent, professional accountants who examine financial statements to *express an opinion*. The opinion reflects the auditors' assessment of the statements' fairness, which is determined by the extent to which they are prepared in compliance with GAAP. The auditor adds credibility to the financial statements, which increases the confidence of capital market participants relying on that information.
question
List three key provisions of the Sarbanes-Oxley Act of 2002. Order your list from most important to least important in terms of the likely long-term impact on the accounting profession and financial reporting.
answer
On July 30, 2002, President Bush signed into law the Sarbanes-Oxley Act of 2002. The most dramatic change to federal securities laws since the 1930s, the Act radically redesigns federal regulation of public company corporate governance and reporting obligations. It also significantly tightens accountability standards for directors and officers, auditors, securities analysts, and legal counsel. Student opinions as to the relative importance of the key provisions of the act will vary. Key provisions in the order of presentation in the text are: - Creation of an Oversight Board - Corporate executive accountability - Nonaudit services - Retention of work papers - Auditor rotation - Conflicts of interest - Hiring of auditor - Internal control
question
Explain what is meant by "adverse economic consequences" of new or changed accounting standards.
answer
New accounting standards, or changes in standards, can have significant differential effects on companies, investors and creditors, and other interest groups by causing redistribution of wealth. There also is the possibility that standards could harm the economy as a whole by causing companies to change their behavior.
question
Why does the FASB undertake a series of elaborate information-gathering steps before issuing a substantive accounting standard?
answer
The FASB undertakes a series of elaborate information gathering steps before issuing an accounting standard to determine consensus as to the preferred method of accounting, as well as to anticipate adverse economic consequences.
question
What is the purpose of the FASB's conceptual framework?
answer
The purpose of the conceptual framework is to *guide the Board* in developing accounting standards by *providing an underlying foundation* and basic reasoning on which to consider merits of alternatives. The framework does not prescribe GAAP.
question
Discuss the terms "relevance" and "faithful representation" as they relate to financial accounting information.
answer
Relevance and faithful representation are the primary qualitative characteristics that make information decision-useful. Relevant information will possess *predictive and/or confirmatory value*. Faithful representation is the extent to which there is agreement between a measure or description and the phenomenon it purports to represent.
question
What are the components of relevant information? What are the component of faithful representation?
answer
The components of relevant information are predictive and/or confirmatory value. The components of faithful representation are completeness, neutrality, and freedom from error.
question
Explain what is meant by: The benefits of accounting information must exceed the costs.
answer
The benefit from providing accounting information is increased decision usefulness. If the information is relevant and possesses faithful representation, it will improve the decisions made by investors and creditors. However, there are costs to providing information that include costs to gather, process, and disseminate that information. There also are costs to users in interpreting the information as well as possible adverse economic consequences that could result from disclosing information. Information should not be provided unless the benefits exceed the costs.
question
What is meant by the term "materiality" in financial reporting?
answer
Information is material if it is deemed to have an effect on a decision made by a user. The threshold for materiality will depend principally on the relative dollar amount of the transaction being considered. One consequence of materiality is that GAAP need not be followed in measuring and reporting a transaction if that transaction is not material. The threshold for materiality has been left to subjective judgment.
question
List Elements as outlined in SFAC 3/6
answer
1. Assets are probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events. 2. Liabilities are probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions. 3. Equity is the residual interest in the assets of any entity that remains after deducting its liabilities. 4. Investments by owners are increases in equity resulting from transfers of resources, usually cash, to a company in exchange for ownership interest. 5. Distributions to owners are decreases in equity resulting from transfers to owners. 6. Revenues are inflows of assets or settlements of liabilities from delivering or producing goods, rendering services, or other activities that constitute the entity's ongoing major or central operations. 7. Expenses are outflows or other using up of assets or incurrences of liabilities during a period from delivering or producing goods, rendering services, or other activities that constitute the entity's ongoing major or central operations. 8. Gains are defined as increases in equity from peripheral or incidental transactions of an entity. 9. Losses represent decreases in equity arising from peripheral or incidental transactions of an entity. 10. Comprehensive income is defined as the change in equity of an entity during a period from nonowner transactions.
question
What are the four basic assumptions underlying GAAP?
answer
The four basic assumptions underlying GAAP are (1) the economic entity assumption, (2) the going concern assumption, (3) the periodicity assumption, and (4) the monetary unit assumption.
question
What is the economic entity assumption?
answer
All economic events can be identified with a particular economic entity
question
What is the monetary unit assumption?
answer
In the U.S., financial statement elements should be measured in terms of the U.S. dollar.
question
What is the going concern assumption?
answer
The going concern assumption means that, in the absence of information to the contrary, it is anticipated that a business entity will continue to operate indefinitely. This assumption is important to many broad and specific accounting principles such as the historical cost principle.
question
Explain the periodicity assumption.
answer
The periodicity assumption relates to needs of external users to receive timely financial information. This assumption requires that the economic life of a company be divided into artificial periods for financial reporting. Companies usually report to external users at least once a year.
question
What are the four key accounting practices that often are referred to as principles in current GAAP?
answer
The four key broad accounting principles that guide accounting practice are (1) the historical cost or original transaction value principle, (2) the realization or revenue recognition principle, (3) the matching principle, and (4) the full disclosure principle.
question
What are two advantages to basing the valuation of assets and liabilities on their historical cost?
answer
Two important reasons to base valuation on historical cost are (1) historical cost provides important cash flow information since it represents the cash or cash equivalent paid for an asset or received in exchange for the assumption of a liability, and (2) historical cost valuation is the result of an exchange transaction between two independent parties and the agreed upon exchange value is, therefore, objective and possesses a high degree of verifiability.
question
Describe how revenue recognition relates to transferring goods and services.
answer
The realization principle requires that two criteria be satisfied before revenue can be recognized: 1. The earnings process is judged to be complete or virtually complete, and, 2. There is reasonable certainty as to the collectibility of the asset to be received (usually cash).
question
What are the four different approaches to implementing expense recognition? Give an example of an expense that is recognized under each approach.
answer
The four different approaches to implementing the matching principle are: 1. Recognizing an expense based on an exact cause-and-effect relationship between a revenue and expense event. Cost of goods sold is an example of an expense recognized by this approach. 2. Recognizing an expense by identifying the expense with the revenues recognized in a specific time period. Office salaries are an example of an expense recognized by this approach. 3. Recognizing an expense by a systematic and rational allocation to specific time periods. Depreciation is an example of an expense recognized by this approach. 4. Recognizing expenses in the period incurred, without regard to related revenues. Advertising is an example of an expense recognized by this approach.
question
In addition to the financial statement elements arrayed in the basic financial statements, what are some other ways to disclose financial information to external users?
answer
In addition to the financial statement elements arrayed in the basic financial statements, information is disclosed by means of parenthetical or modifying comments, notes, and supplemental financial statements.
question
Briefly describe the inputs that companies should use when determining fair value. Organize your answer according to preference levels, from highest to lowest priority.
answer
GAAP prioritizes the inputs companies should use when determining fair value. The highest and most desirable inputs, Level 1, are quoted market prices in active markets for identical assets or liabilities. Level 2 inputs are other than quoted prices that are observable, including quoted prices for similar assets or liabilities in active or inactive markets and inputs that are derived principally from observable related market data. Level 3 inputs, the least desirable, are inputs that reflect the entity's own assumptions about the assumptions market participants would use in pricing the asset or liability based on the best information available in the circumstances.
question
What measurement attributes are commonly used in financial reporting?
answer
Common measurement attributes are historical cost, net realizable value, present value, and fair value.
question
Distinguish between the revenue/expense and the asset/liability approaches to setting financial reporting standards.
answer
Under the revenue/expense approach, revenues and expenses are considered primary, and assets, liabilities, and equities are secondary in the sense of being recognized at the time and amount necessary to achieve proper revenue and expense recognition. Under the asset/liability approach, assets and liabilities are considered primary, and revenues and expenses are secondary in the sense of being recognized at the time and amount necessary to allow recognition and measurement of assets and liabilities as required by their definitions.
question
What are the functions of the conceptual framework under IFRS?
answer
Under IFRS, the conceptual framework provides guidance to accounting standard setters but also provides GAAP when more specific accounting standards do not provide guidance.
question
What is the standard-setting body responsible for determining IFRS? How does it obtain its funding?
answer
The International Accounting Standards Board (IASB) is responsible for determining IFRS. The IASB is funded by the International Accounting Standards Committee Foundation (IASCF), which in turn receives much of its funding through voluntary donations by accounting firms and corporations.
question
In its Final Staff Report (issued in 2012), what type of convergence between U.S. GAAP and IFRS did the SEC staff argue was not feasible? What reasons did the SEC staff give for that conclustion?
answer
The SEC issued two studies comparing U.S. GAAP and IFRS and analyzing how IFRS are applied globally. In these studies, the SEC identified key differences between U.S. GAAP and IFRS, and noted that U.S. GAAP provides significantly more guidance about particular transactions or industries. The SEC also noted some diversity in the application of IFRS that suggests the potential for non-comparability of financial statements across countries and industries. The SEC postponed making a final decision about conversion to IFRS, but continued to discuss "condorsement" as a reasonable approach.
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question
What is the function and primary focus of financial accounting?
answer
- Providing *relevant financial information* about various kinds of organizations to different types of external users - The primary focus of financial accounting is on the financial information provided by profit-oriented companies to their present and potential investors and creditors
question
What is meant by the phrase "efficient allocation of resources"? What mechanism fosters the efficient allocation of resources in the United States?
answer
Resources are efficiently allocated if they are given to enterprises that will use them to provide goods and services desired by society and not to enterprises that will waste them. The *capital markets* are the mechanism that fosters this efficient allocation of resources
question
Identify two important variables to be considered when making an investment decision.
answer
- expected rate of return - uncertainty or risk of that expected return
question
What must a company do in the long run to be able to provide a return to investors and creditors?
answer
In the long run, a company will be able to provide investors and creditors with a rate of return only if it can generate a profit. That is, it must be able to use the resources provided to it to generate cash receipts from selling a product or service that exceed the cash disbursements necessary to provide that product or service.
question
What is the primary objective of financial accounting?
answer
provide *investors and creditors* with information that will help them make *investment and credit* decisions
question
Define net operating cash flows. Briefly explain why periodic net operating cash flows may not be a good indicator of future operating cash flows.
answer
Net operating cash flows are the difference between cash receipts and cash disbursements during a period of time from transactions related to providing goods and services to customers. Net operating cash flows may not be a good indicator of future cash flows because, by ignoring uncompleted transactions, they may not match the accomplishments and sacrifices of the period.
question
What is meant by GAAP? Why should all companies follow GAAP in reporting to external users?
answer
- GAAP (generally accepted accounting principles) are a dynamic set of both broad and specific guidelines that a company should follow in measuring and reporting the information in their financial statements and related notes - It is important that all companies follow GAAP so that investors can *compare financial information across companies* to make their resource allocation decisions
question
Explain the roles of the SEC and the FASB in the setting of accounting standards.
answer
Congress --> SEC --> sets accounting and reporting standards for publicly traded companies SEC (retained power)--> (delegated to) FASB --> responsible for setting accounting standards In 1934, Congress created the SEC and gave it the job of *setting accounting and reporting standards* for companies whose securities are publicly traded. The SEC has retained the power, but has delegated the task to private sector bodies. The current private sector body responsible for setting accounting standards is the FASB.
question
Explain the role of the auditor in the financial reporting process.
answer
Auditors are independent, professional accountants who examine financial statements to *express an opinion*. The opinion reflects the auditors' assessment of the statements' fairness, which is determined by the extent to which they are prepared in compliance with GAAP. The auditor adds credibility to the financial statements, which increases the confidence of capital market participants relying on that information.
question
List three key provisions of the Sarbanes-Oxley Act of 2002. Order your list from most important to least important in terms of the likely long-term impact on the accounting profession and financial reporting.
answer
On July 30, 2002, President Bush signed into law the Sarbanes-Oxley Act of 2002. The most dramatic change to federal securities laws since the 1930s, the Act radically redesigns federal regulation of public company corporate governance and reporting obligations. It also significantly tightens accountability standards for directors and officers, auditors, securities analysts, and legal counsel. Student opinions as to the relative importance of the key provisions of the act will vary. Key provisions in the order of presentation in the text are: - Creation of an Oversight Board - Corporate executive accountability - Nonaudit services - Retention of work papers - Auditor rotation - Conflicts of interest - Hiring of auditor - Internal control
question
Explain what is meant by "adverse economic consequences" of new or changed accounting standards.
answer
New accounting standards, or changes in standards, can have significant differential effects on companies, investors and creditors, and other interest groups by causing redistribution of wealth. There also is the possibility that standards could harm the economy as a whole by causing companies to change their behavior.
question
Why does the FASB undertake a series of elaborate information-gathering steps before issuing a substantive accounting standard?
answer
The FASB undertakes a series of elaborate information gathering steps before issuing an accounting standard to determine consensus as to the preferred method of accounting, as well as to anticipate adverse economic consequences.
question
What is the purpose of the FASB's conceptual framework?
answer
The purpose of the conceptual framework is to *guide the Board* in developing accounting standards by *providing an underlying foundation* and basic reasoning on which to consider merits of alternatives. The framework does not prescribe GAAP.
question
Discuss the terms "relevance" and "faithful representation" as they relate to financial accounting information.
answer
Relevance and faithful representation are the primary qualitative characteristics that make information decision-useful. Relevant information will possess *predictive and/or confirmatory value*. Faithful representation is the extent to which there is agreement between a measure or description and the phenomenon it purports to represent.
question
What are the components of relevant information? What are the component of faithful representation?
answer
The components of relevant information are predictive and/or confirmatory value. The components of faithful representation are completeness, neutrality, and freedom from error.
question
Explain what is meant by: The benefits of accounting information must exceed the costs.
answer
The benefit from providing accounting information is increased decision usefulness. If the information is relevant and possesses faithful representation, it will improve the decisions made by investors and creditors. However, there are costs to providing information that include costs to gather, process, and disseminate that information. There also are costs to users in interpreting the information as well as possible adverse economic consequences that could result from disclosing information. Information should not be provided unless the benefits exceed the costs.
question
What is meant by the term "materiality" in financial reporting?
answer
Information is material if it is deemed to have an effect on a decision made by a user. The threshold for materiality will depend principally on the relative dollar amount of the transaction being considered. One consequence of materiality is that GAAP need not be followed in measuring and reporting a transaction if that transaction is not material. The threshold for materiality has been left to subjective judgment.
question
List Elements as outlined in SFAC 3/6
answer
1. Assets are probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events. 2. Liabilities are probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions. 3. Equity is the residual interest in the assets of any entity that remains after deducting its liabilities. 4. Investments by owners are increases in equity resulting from transfers of resources, usually cash, to a company in exchange for ownership interest. 5. Distributions to owners are decreases in equity resulting from transfers to owners. 6. Revenues are inflows of assets or settlements of liabilities from delivering or producing goods, rendering services, or other activities that constitute the entity's ongoing major or central operations. 7. Expenses are outflows or other using up of assets or incurrences of liabilities during a period from delivering or producing goods, rendering services, or other activities that constitute the entity's ongoing major or central operations. 8. Gains are defined as increases in equity from peripheral or incidental transactions of an entity. 9. Losses represent decreases in equity arising from peripheral or incidental transactions of an entity. 10. Comprehensive income is defined as the change in equity of an entity during a period from nonowner transactions.
question
What are the four basic assumptions underlying GAAP?
answer
The four basic assumptions underlying GAAP are (1) the economic entity assumption, (2) the going concern assumption, (3) the periodicity assumption, and (4) the monetary unit assumption.
question
What is the economic entity assumption?
answer
All economic events can be identified with a particular economic entity
question
What is the monetary unit assumption?
answer
In the U.S., financial statement elements should be measured in terms of the U.S. dollar.
question
What is the going concern assumption?
answer
The going concern assumption means that, in the absence of information to the contrary, it is anticipated that a business entity will continue to operate indefinitely. This assumption is important to many broad and specific accounting principles such as the historical cost principle.
question
Explain the periodicity assumption.
answer
The periodicity assumption relates to needs of external users to receive timely financial information. This assumption requires that the economic life of a company be divided into artificial periods for financial reporting. Companies usually report to external users at least once a year.
question
What are the four key accounting practices that often are referred to as principles in current GAAP?
answer
The four key broad accounting principles that guide accounting practice are (1) the historical cost or original transaction value principle, (2) the realization or revenue recognition principle, (3) the matching principle, and (4) the full disclosure principle.
question
What are two advantages to basing the valuation of assets and liabilities on their historical cost?
answer
Two important reasons to base valuation on historical cost are (1) historical cost provides important cash flow information since it represents the cash or cash equivalent paid for an asset or received in exchange for the assumption of a liability, and (2) historical cost valuation is the result of an exchange transaction between two independent parties and the agreed upon exchange value is, therefore, objective and possesses a high degree of verifiability.
question
Describe how revenue recognition relates to transferring goods and services.
answer
The realization principle requires that two criteria be satisfied before revenue can be recognized: 1. The earnings process is judged to be complete or virtually complete, and, 2. There is reasonable certainty as to the collectibility of the asset to be received (usually cash).
question
What are the four different approaches to implementing expense recognition? Give an example of an expense that is recognized under each approach.
answer
The four different approaches to implementing the matching principle are: 1. Recognizing an expense based on an exact cause-and-effect relationship between a revenue and expense event. Cost of goods sold is an example of an expense recognized by this approach. 2. Recognizing an expense by identifying the expense with the revenues recognized in a specific time period. Office salaries are an example of an expense recognized by this approach. 3. Recognizing an expense by a systematic and rational allocation to specific time periods. Depreciation is an example of an expense recognized by this approach. 4. Recognizing expenses in the period incurred, without regard to related revenues. Advertising is an example of an expense recognized by this approach.
question
In addition to the financial statement elements arrayed in the basic financial statements, what are some other ways to disclose financial information to external users?
answer
In addition to the financial statement elements arrayed in the basic financial statements, information is disclosed by means of parenthetical or modifying comments, notes, and supplemental financial statements.
question
Briefly describe the inputs that companies should use when determining fair value. Organize your answer according to preference levels, from highest to lowest priority.
answer
GAAP prioritizes the inputs companies should use when determining fair value. The highest and most desirable inputs, Level 1, are quoted market prices in active markets for identical assets or liabilities. Level 2 inputs are other than quoted prices that are observable, including quoted prices for similar assets or liabilities in active or inactive markets and inputs that are derived principally from observable related market data. Level 3 inputs, the least desirable, are inputs that reflect the entity's own assumptions about the assumptions market participants would use in pricing the asset or liability based on the best information available in the circumstances.
question
What measurement attributes are commonly used in financial reporting?
answer
Common measurement attributes are historical cost, net realizable value, present value, and fair value.
question
Distinguish between the revenue/expense and the asset/liability approaches to setting financial reporting standards.
answer
Under the revenue/expense approach, revenues and expenses are considered primary, and assets, liabilities, and equities are secondary in the sense of being recognized at the time and amount necessary to achieve proper revenue and expense recognition. Under the asset/liability approach, assets and liabilities are considered primary, and revenues and expenses are secondary in the sense of being recognized at the time and amount necessary to allow recognition and measurement of assets and liabilities as required by their definitions.
question
What are the functions of the conceptual framework under IFRS?
answer
Under IFRS, the conceptual framework provides guidance to accounting standard setters but also provides GAAP when more specific accounting standards do not provide guidance.
question
What is the standard-setting body responsible for determining IFRS? How does it obtain its funding?
answer
The International Accounting Standards Board (IASB) is responsible for determining IFRS. The IASB is funded by the International Accounting Standards Committee Foundation (IASCF), which in turn receives much of its funding through voluntary donations by accounting firms and corporations.
question
In its Final Staff Report (issued in 2012), what type of convergence between U.S. GAAP and IFRS did the SEC staff argue was not feasible? What reasons did the SEC staff give for that conclustion?
answer
The SEC issued two studies comparing U.S. GAAP and IFRS and analyzing how IFRS are applied globally. In these studies, the SEC identified key differences between U.S. GAAP and IFRS, and noted that U.S. GAAP provides significantly more guidance about particular transactions or industries. The SEC also noted some diversity in the application of IFRS that suggests the potential for non-comparability of financial statements across countries and industries. The SEC postponed making a final decision about conversion to IFRS, but continued to discuss "condorsement" as a reasonable approach.