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Conceptual Framework

Establishes concepts that underlie financial reporting

Coherent system of concepts that flow from an objective

1

4 objectives of conceptual framework?

1 identify boundaries of financial reporting

2 selecting transactions, other events and circumstances
To be represented

3 how they should be recognized and measured

4 how they are summarized and reported

2

Why we need conceptual framework?

1 rule making should build on established concepts

2 quickly solve new and emerging practical problems
By referring to an existing framework of basic theory

3

FASB 3 level framework for financial reporting?

Level 1 the purpose/objective of financial reporting

Level 2 qualitative characteristics that make accounting
Info useful and elements of financial statements (assets,
Liabilities, etc.)

Level 3 identifies recognition, measurement, disclosure
Concepts used in establishing/ applying accounting
Standards to specific concepts

4

First Level: Objective of general purpose financial reporting?

Report to present and potential equity investors, lenders,
And other creditors in making decisions about providing
Resources to entity

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Purpose of second level of financial accounting framework?

Form a bridge btw why of accounting (objective) and
The how of accounting (recognition, measurement,
Financial statement presentation)

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Qualitative characteristics of financial accounting?

Each qualitative characteristic contributes to
decision usefulness of financial reporting info

Either fundamental or enhancing

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Fundamental Quality: Relevance, 3 ingredients?

Ability to make a difference in a decision

1 predictive value, 2 confirmatory value, 3 materiality

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Predictive value?

Value as input to predictive processes used by investors
To form their own expectations about the future

Ex. Analyze UPS shares current resources, dividends
And earnings performance to predict company's future earnings

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Confirmatory value

Issuing financial statements confirms the current value
Of the company

10

Materiality, rule of thumb about whether immaterial?

Whether information is worth stating based on
It's magnitude and context are relevant to financial decisions

Relative size of item determines materiality

Anything under 5 percent of net income is immaterial

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Fundamental Quality: Faithful Representation, 3 ingredients?

Numbers and descriptions match what really existed
And happened

1 completeness, 2 neutrality, 3 free from error

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4 enhancing qualities?

Comparability,
Verifiability,
timeliness,
understandability

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Enhancing qualities define?

These characteristics distinguish more useful info
From less useful info

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Comparability

Enables users to identify real similarities and
Differences in economic events between companies

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Consistency

When company applies the same accounting treatment
To similar events from period to period

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Verifiability

Occurs when independent measures, using the same
Methods obtain similar results

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Timeliness

Having info available to decision makers before it loses
It's capacity to influence decisions

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Understandability

Quality of info that lets reasonably informed users
See its significance

Understandability is enhanced when info is classified,
Characterized, presented clearly and precisely

19

Basic elements of financial statements



10 interrelated elements that directly relate to measuring
Performance and financial status of a business enterprise

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First three elements from a moment in time?

Assets, liabilities, equity are resources and claims to
Resources at a moment in time

21

Elements that describe a period in time?

Describe events, transactions and circumstances that
Affect a company during a period in time

22

4 basic assumptions of financial accounting?

1 economic entity
2 going concern
3 monetary unit
4 periodicity

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Economic entity assumption

Economic activity can be identified with particular
Unit of accountability

Company keeps activity separate and distinct from
It's owners and any other business unit

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Going concern assumption

The company will have a long life

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Monetary unit assumption

Money provides appropriate basis for measurement and analysis

26

Periodicity

Financial reporting in artificial time periods

Ex. Quarterly, annually

27

The quicker the company releases financial information...

The more likely it has errors and is inaccurate

28

4 basic principles of accounting?

1 measurement
2 revenue recognition
3 expense recognition
4 full disclosure

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Historical cost principle

Assets and liabilities recorded at acquisition prices

Historical cost is Verifiable benchmark for measuring
Historical trends

30

Fair value

Price that would be received to sell an asset or paid
To transfer a liability in the current market to date

31

Fair value principle

Use of fair value measurements in financial statements

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Fair value option

Option of measuring assets at fair value on financial
Statements

33

Performance obligation

When company agrees to perform a service or
Sell a product to a customer

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Revenue recognition principle

Requires companies recognize revenue in accounting
Period when performance obligation is satisfied

35

Expense recognition principle

Implemented by matching efforts (expenses) with
Accomplishments (revenues)

36

Product costs

Material, labor, overhead attach to product

37

Period costs

Officer's salaries, other administrative expenses attach
To period

38

Product costs: relationship? Recognition?

Direct relationships btw cost and revenue

Recognized in period of revenue (matching)

39

Period costs: relationship? Recognition?

No direct relationship btw cost and revenue

Expenses as incurred

40

Full disclosure principle

Sufficient detail to disclose matters that make a difference
To users

Sufficient condensation to make the info understandable

41

Supplementary information

May include details or amounts that present different
perspective from that adopted in financial statements

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Notes to financial statements

Amplify info presented in main body of statements

43

Pro forms earnings

Exaggerates positive earnings number, hiding
True profitability of company

44

Cost constraint AKA Cost benefit relationship

Companies must weigh costs of providing info
Against the benefits that can be derived from using it

45

6 common costs in cost benefit analysis?

1Costs of collecting and processing
2 disseminating
3 auditing
4 potential litigation
5 disclosure to competitors
6 analysis and interpretation

46

2 common Benefits to preparers of cost benefit analysis?

Management control, access to capital at lower cost

47

3 Common benefits to users of cost benefit analysis?

1 better info allocation
2 tax assessment
3 rate regulation