Conceptual Framework Flashcards
Operating procedure for issuing a new Financial Accounting Standards Board (FASB) Statement
A new statement is issued only after a majority vote by members of the FASB. At least 4 of the 7 members of the FASB must vote in favor of a proposed Statement of Financial Accounting Standards.
Who must comply with GAAP?
Of course, all publicly traded companies must comply with GAAP. Essentially, all companies that rely on external sources of capital require financial statements and, therefore, must comply with GAAP.
For example, a privately-held firm may require a loan. In order to obtain the loan, the firm must present audited financial statements.
Negative economic consequences include?
The inability to raise capital. A proposed standard may cause firm earnings to fall when it is adopted. Firms will be concerned that lower earnings make it more difficult to sell stock or secure loans. As a result, negative economic consequences become a focal point for arguments against the proposed standard.
Three aspects of financial reporting affected by GAAP
Recognition: A recognized item is recorded in an account and ultimately affects the financial statements.
Measurement: Concerns the dollar amount assigned to an item.
Disclosure: Many unrecognized amounts are reported in the footnotes to complete the portrayal of the firm’s financial position and performance.
Converting from accrual basis income to cash basis and converting from cash basis income to accrual basis
Accrual income to cash basis
A = L + E
ΔA = ΔL + ΔE
Δcash + Δother assets = ΔL + ΔE
Δcash = ΔL + ΔE - Δother assets
Start with Net Income and then add/subtract the RHS, which will add up to the change in cash.
If you are asked to change from cash to accrual, all the signs are opposite.
Which financial statement would a potential investor use primarily to assess the company’s liquidity and financial flexibility?
Balance Sheet. BS discloses assets and liabilities, usually classified by proximity to realization (assets) or payment (liabilities). The balance shows the relative magnitude of assets and liabilities and therefore the ability to pay obligations in the short and long term. It also shows the degree of leverage and ability to adapt to changing financial conditions as well as the ability to manage future cash flows when conditions change
Prior period adjustments are not shown on the income statement. Where are they shown?
Prior period adjustments are shown on the Statement of Retained Earnings as adjustments to the beginning balance if retained earnings in the year the error is discovered.
What are the items that would appear to be income items that are not reflected in net income?
These items are reflected in the Statement if Comprehensive Income, which reports all non-owner changes in equity over a period of time.
The SOCI reports all NI (or loss) and the items included in comprehensive income that are not part of NI. Those items include:
(a) Unrealized gains and losses on available-for-sale securities.
(b) Adjustments in the calculation of the pension liability.
(c) Foreign currency translation adjustments
(d) Deferrals of certain gains or losses on hedge accounting.
Tell me about the FASB Accounting Standards Codification.
The Codification is the sole source of US GAAP, other than SEC GAAP, for nongovernmental entities. IFRS are not US GAAP and are therefore not included in the Codification. Accounting Standards Updates (ASUs) are issued as part of the due process activities of the FASB for amending the Codification.
Which characteristic of accounting information primarily allows users of financial statements to generate predictions about an organization?
Relevance. Predictive value and confirmatory value are components of relevance. Note that the term “reliability” is no longer part of the conceptual framework.
Predictive value helps users increase the likelihood of forecasting the outcome of events.
What does faithful representation encapsulate?
Faithful representation includes completeness, neutrality, and free from error.
Neutrality means lack of bias, so that the financial reporting does not have a preconceived objective or agenda.
What is recognition?
Recognition is the process of formally recording and reporting an item as one of the elements of financial statements. When an item is recognized, it affects an account balance reported in the financial statements. The item may not be separately listed, but it will be reflected in one if the accounts in the statements.
How does comparability relate to both accounting relevance and faithful representation?
Comparability is the quality of information that enables users to identify similarities and differences between sets of information. For information to be comparable, it must be both relevant (make a difference to the user) and faithfully represented.
What is the conceptual framework meant to establish?
The objectives and concepts for use in developing standards of financial accounting and reporting.
Do the financial statements directly provide info about management performance?
The financial statements directly provide information about enterprise performance but not about management performance. There are too many factors that affect the firm’s performance to be able to single out management’s contribution, and also, current enterprise performance is affected by the actions of past managers who may not be with the enterprise anymore.
