Accounting Principles and Standards

Question 1

List

The 12 Fundamental Accounting Principles

Answer 1

1. Accrual Basis of Accounting
2. Revenue Recognition
3. Historical Cost
4. Matching
5. Materiality
6. Conservatism
7. Economic Entity
8. Going Conern
9. Monetary Unit
10. Full Disclosure
11. Consistency
12. Objectivity

Question 2

Define

Accrual Basis of Accounting Principle

Answer 2

States that the financial aspects of economoic events are recorded in the accounting period in which they occur regardless of whether cash bas been exchanged.

Question 3

Define

Revenue Recognition Principle

Answer 3

States that revenue is earned and recognized upon product delivery or service completion without regard to the timing of cash flow.

Question 4

Define

Historical Cost Principle

Answer 4

States that assets and liabilities are recorded at the cost at which they were acquired or assumed, where cost refers to the original amount expended to acquire the item.

Question 5

Define

Matching Principle

Answer 5

States that the costs of doing business should be recorded in the same period as the economic benefits they generate, irrespective as when they are actually paid.
* Ex: Depreciation expense - the cost of fixed asset is allocated over its useful life as it generate benefits over that time.

Question 6

Define

Materality Principle

Answer 6

States that financial information is material to the financial statements if it would change the opinion or view of a reasonable person.
* It is important to note that the concept of materality is relative in size and importance - what could be ‘material’ to one company may not be for another.

Question 7

Define

Conservatism Principle

Answer 7

Provides guidance on how to record transactions particularly those involving uncertainty or estimates. If a situation arises where there are two acceptable alternatives for reporting an item, the alternative that will result in smaller net income and/or asset balances should be used.
* Ex: Potential losses from Lawsuits - assumes the worse case scenario.

Question 8

Define

Economic Entity Principle

Answer 8

States the following: (1) transactions carried out by a business are separated from its owner and (2) transactions carried out by different businesses must be accounted for separately. This allows financial statement users to assess the value and performance of a business separately from its ownership activity.
* Ex: a business owner purchases an asset with funds from his personal bank. Thus, the asset cannot be recorded on the financial statements according unless it is sold or contributed to the company.

Question 9

Define

Monetary Unit Principle

Answer 9

States that only business transactions that are quantifiable and can be expressed in terms of monetary units are recorded in the financial statements. Also, monetary units must be stable, reliable, relevant, and useful to all companies.
* Ex: Immediate value of new executives cannot be expressed in monetary units and thus should not be recorded in the accounting records.

Question 10

Define

Going Concern Principle

Answer 10

States that the financial statements are prepared assuming the organization will continue to operate its business for the foreseeable future. Thus, every decision is taken with the objective of operating the business rather than liquidating it.

Question 11

Define

Full Disclosure Principle

Answer 11

States that any information that would be considered material to a user of the financial statements should be disclosed in the statements or the footnotes thereto.
* Examples include: material loss, audited financial statements, changes in policies, non-monetary transactions, etc.

Question 12

Define

Consistency Principle

Answer 12

States that consistent information is prepared using the same accounting methods for similar events and transactions over time. This is crucial for comparative purposes.
* Example: a change in the accounting policy dealing with a company’s inventory valuation. Assuming the reasons are justified, the change must be applied consistently the following year

Question 13

Define

Objectivity Principle

Answer 13

States that accounting records and financial statements should be independent and free from bias (verifiable).
* Example: an accountant preparing a company’s financial statement needs to verify AR. The accountant needs to be referencing supporting documents (invoices, receipts, etc.) rather than relying on the company system’s number.

Question 14

Answer the following:

What are the two fundamental characteristics for financial information to be useful?

Answer 14

1. Relevant (must have predictive and confirmatory value)
2. Faithfully represents what it purports to (free from errors, complete and neutral/no bias)

Question 15

Answer the following:

What are the four enhancing characteristics for financial information to be useful?

Answer 15

1. Comparable
2. Verifiable (same conclusions can be arrived from same information by knowledgeable/indepedent observers)
3. Timely
4. Understandable

Question 16

Define

Confirmatory value

Part of what is considered as “relevant” for a financial statement

Answer 16

Information that provides feedback about (confirms or changes) previous evaluations

Question 17

Define

Lease

Answer 17

A contract that conveys the right to control the use of an indentified asset for a period of time in exchange for consideration.

Question 18

List the following:

The two criteria for a right to control be conveyed for a lease

Answer 18

1. Right to obtain substantially all (>= 90%) of the economic benefits
2. Right to direct to use of the asset

Question 19

Answer the following:

What is the difference between Accounting treatment of leases between IFRS and US GAAP?

Answer 19

All leases are classified as ‘finance’ leases under IFRS, but US GAAP separates leases into (1) operating and (2) finance/capital leases.

Question 20

Answer the following:

How do you recognize the commencement of leases on the balance sheet?

Lessee-side ONLY

Answer 20

1. Debit “Right-of-use Asset” - asset side
2. Credit “Lease Liability” - liability side
   * Note: ALL leases (finance/operating) will be recognized the SAME on the balance sheet

Question 21

Define:

Lease Liability

Lessee-side ONLY

Answer 21

PV of the remaining lease payments that is discounted at either the rate implicit in the lease, OR, assuming this is not readily available, the lessee’s incremental borrowing rate (IBR).

Question 22

Define:

Right-of-Use Asset

Lessee-side ONLY

Answer 22

The amount of the lease liability at lease commencement + lease payments made before commencement date (minus any lease incentives received) + initial direct cost incurred.

Question 23

Answer the following:

Over the lease term, what is the impact of subsequent recognition and measurement on our financials?

Answer 23

The right-of-use asset must be amortized and interest expense on the lease liability must be recorded. This will impact the income statement and how the lease is classified will play a factor.

Question 24

Answer the following:

On a Finance / Capital Lease, how are we to record subsequent recognition and measurement?

Answer 24

1. Record interest expense - which is based on the outstanding lease liability balance
2. Record amortization expense - this will be the straight-line over the shorter of the lease term or the asset useful life

Question 25

Answer the following:

On a Operating Lease, how are we to record subsequent recognition and measurement?

Answer 25

Record Lease Expense - which is a combination of both the interest expense and amortization expense

1. Interest expense - which is based on the outstanding lease liability balance
2. Amortization expense - this will be the difference between the average annual lease payment and interest expense

Question 26

Answer the following:

What are the differences when comparing finance and operating lease when evaluating expenses?

Answer 26

For finance lease:
a) Total expenses are usually higher in earlier periods and decrease over time
b) Amortization expense remains constant during the lease term (straight-line depreciation)
c) Interest expense decreases over time as the lease liability is reduced each year
For operating lease:
a) Total lease expense equals to the annual lease payment and is constant over the lease term if the lease payments are the same every year

Question 27

Define:

Income Tax Expense

Answer 27

The total amount included on the income statement for the period and is the summation of the current and deferred tax expenses.

Question 28

Define:

Current Tax Expense

Answer 28

The amount of tax due to tax authorities in the current period.

Question 29

Define:

Deferred Tax Expense

Answer 29

The amount of tax due to tax authorities in future periods.

Question 30

Define:

Accounting Income

Answer 30

The profit or loss for a period before deducting tax expense. This is commonly known as “EBT” or Earning/Income Before Tax.

Question 31

Define:

Taxable Income

Answer 31

The profit or loss for a period determined in accordance with rules established by taxation authorities. This is the taxable income on tax returns.

Question 32

Answer the following:

Because income taxes are based on taxable income and not accounting income, how do we reconcile accounting income into taxable income?

Answer 32

Starting with Accounting Income:
“+” Expenses not deductible under tax laws but recognized for accounting purposes
“+” Income included under tax laws but not recognized for accounting purposes
“-“ Expenses deductible under tax laws but not recognized for accounting purposes
“-“ Income not included under tax laws but recognized for accounting purposes
= Taxable Income

Question 33

Answer the following:

Convert this example from Accounting Income to Taxable Income

Answer 33

Answer

Question 34

Define:

Carrying Amount

Answer 34

The net book value of an asset or liability recorded on a company’s balance sheet for accounting purposes

Question 35

Define:

Tax Base

Answer 35

The amount attributed to an asset or liability for tax purposes

Question 36

Define:

Temporary Differences

Answer 36

Differences between the carrying amount of assets and liabilitites for accounting purposes and their respective tax bases (or Carrying amount - Tax Base).

Question 37

Define:

Permanent Differences

Answer 37

Differences between the tax and financial reporting of revenue or expense items which will NOT be reversed in the future.

Question 38

Define and list occurances:

Deductible Temporary Differences

Answer 38

Differences that result in amounts that are deductible in determining taxable income of future periods. They give rise to Deferred Tax Assets.

These generally arise when:
1. Taxable Income > Accounting Income
2. Assets’ Tax Base > Carrying Amount
3. Liabilities’ Carrying Amount > Tax Base

Question 39

Define and list occurances:

Taxable Temporary Differences

Answer 39

Differences that result in amounts that are taxable in determining taxable income of future periods. They give rise to Deferred Tax Liabilities.

These generally arise when:
1. Accounting Income > Taxable Income
2. Assets’ Tax Base < Carrying Amount
3. Liabilities’ Carrying Amount < Tax Base

Question 40

Define and list occurances:

Deferred Tax Assets

Answer 40

The amounts of income tax recoverable in future periods.

Question 41

Define and list occurances:

Deferred Tax Liabilities

Answer 41

The amounts of income tax payable in future periods.

Question 42

Define:

Share-based payment (SBP) transactions

Answer 42

Occur when an entity receives good and services from a third-party and grant equity instruments or cash amounts based on the value of such equity instruments as consideration.

Question 43

List:

The (5) key elements of share-based payments

Answer 43

1. SBP Classifications (equity-settled vs. cash-settled)
2. Grant Date
3. Vesting Conditions
4. Vesting Period
5. Fair Value at Grant Date

Question 44

Define:

Equity-settled Payments

Answer 44

Occur when transactions are settled using an entity’s own equity instruments. For example: stock options

Question 45

Define:

Cash-settled Payments

Answer 45

Occur when transactions are settled in cash, the amount of which is based on the value of an equity instruments. For example: share appreciation rights

Question 46

Define:

Business Combinations

Answer 46

A transaction or other event in which an acquirer obtains control of one or more businesses

Important to note the difference b.w asset acquistion and business comb.

Question 47

List:

The (4) key elements business combinations

Answer 47

1. Business - integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing G/S to customers, generating investment income or other income from ordinary activities
2. Acquisition Date - the date on which the acquirer obtains control of the acquiree
3. Acquirer - the entity that obtains control of the acquiree
4. Acquiree - the business or businesses that the acquirer obtains control of in a business combination

Question 48

Define:

Fair Value Concentration Test

Answer 48

Designed to quickly identify whether a transaction is more akin to an asset acquisition or business combination.

Question 49

Define and list:

The Accounting Treatment for Business Combination

Answer 49

The acquisition method is used to account for business combinations and it has four steps:
1. Identify the Acquirer
2. Determine the Acquisition Date
3. Recognize (recognition principle) and measure the assets acquired, and the liabilities assumed (at fair-value when acquired - measurement principles)
4. Recognize and measure goodwill

Question 50

Define/List formula:

Goodwill

Answer 50

Represents the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognized.

Goodwill = Consideration Transferred - Fair Value of Net Asset Acquired

Note: Fees such as transaction cost, advisory, financing fees, etc. are EXCLUDED from ‘Consideration Transferred’

Question 51

Define:

Financing Fees

Answer 51

Represents the 3rd-party fees incurred by the company when it raise its debt or/and equity.

Ex: Debt Issurance Costs & Share Issue Costs

Question 52

Define:

Debt Issurance Cost

Answer 52

Represents the costs incurred by a company when they raise new debt. These costs are recognized initially on the balance sheet as a contra account under liabilities, and then amortized over the term of the related debt liability.

Examples: Registration Costs, Underwriting Fees, Legal and Accounting Fees, and other Directly Attributable Costs

Question 53

Define:

Share Issue Cost

Answer 53

Represents the costs incurred by a company when they issues to the public. These costs DIRECTLY REDUCE THE PROCEEDS a company receives from an equity offering.

Examples: Registration Fees, Underwriting Fees, Legal and Accounting Fees, and Marketing / Administrative Costs

Question 54

Define:

Transaction Costs

Answer 54

Represents the costs incurred by both acquirers and targets during the course of an M&A transaction. They represent services that have been rendered to and consumed by the acquirer and are expensed as they are incurred.

Examples: Financial Advisory, Legal Fees, Accounting Fees & Related Administrative Costs