Flashcards in FAR 1 - Role and Standard-Setting Process Deck (34):
The purpose of financial accounting is to provide information primarily for...
Investors and creditors
Purpose is provide information relevant to the decision making of investors and creditors. These people make decisions about allocating resources across thousands of firms.
What is the primary protection for investors against fraudulent financial reporting by corporations?
The requirement that financial statements be audited.
It must be performed by independent third party CPAs. The auditors do not prepare the information, nor do they have employment ties with either the reporting firm or the intended audience of the FS. However, even the audit of FS is not a perfect protection as indicated by the frequency of fraud and audit failure.
In reference to proposed accounting standards, the term "negative economic consequences" includes:
A. The cost of complying with GAAP.
B. The inability to raise capital.
C. The cost of government intervention when not in compliance with GAAP.
D. The failure of internal control systems.
B. The inability to raise capital.
A proposed standard may cause firm earnings to fall, for example when they are adopted. Firms will be concerned that lower earnings may make it more difficult to sell stock or to secure loans. As a result, negative economic consequences become a focal point for arguments against the proposed standard.
T/F: The FASB is a governmental unit.
The FASB is a Private sector body.
The FASB has no official connection with the US Government although the SEC, an agency of the federal government, can modify or rescind an accounting standard adopted by the FASB.
The operating procedure for issuing a new FASB statement includes
1. Considers whether to add a project to its agenda, in consultation with the FAF.
2. Conducts research on the topic and issues a Discussion Memo detailing the issues surrounding the topic.
3. Holds a public hearing on the topic.
4. Evaluates the research and comments from interested parties and issues an Exposure Draft.
5. Solicits add'l comments, modifies Exposure Draft if needed.
6. Finalizes the new statement only after a majority vote by the members of the FASB. At least four of the seven members of the FASB must vote in favor of a proposed Statement of Financial Accounting Standards.
7. Issues an Accounting Standards Update (ASU).
T/F: The Wheat Committee was involved in the formation of the FASB.
In 1971, the AICPA appointed the Wheat Committee, which recommended the formation of yet another private sector body - the FASB - to take over the reins from the APB. In 1973, the FASB assumed the role of standard setter for the accounting profession. The FASB is not affiliated with the AICPA.
T/F: Recognition in accounting refers to the process of recording a measurable attribute such that it affects one or more of the FS.
T/F: The Accounting Principles Board was the standard-setting body that immediately preceded the FASB.
In 1959, the AICPA created the Accounting Principles Board (APB), another committee, to take over the work of CAP. The APB is the second private sector group designated to formulate GAAP. Members were required to be CPAs. The APB issued 31 opinions, many of which remain as GAAP, in whole or in part.
T/F: The conceptual framework is not GAAP.
the FASB's conceptual framework plays a role in this process by providing a theoretical structure for guiding the development of a specific standard
Savor Co. had $100,000 in cash-basis pretax income for 1999. At December 31, 1999, accounts receivable had increased by $10,000 and accounts payable had decreased by $6,000 from their December 31, 1998, balances. Compared to the accrual-basis method of accounting, Savor's cash pretax income is:
Lower by $16,000
The computation is: 100,000+10,000+6,000 = 116,000, or a $16,000 increase from cash to accrual.
The increase in accounts receivable would be added to cash income as it increases sales in accrual income.
The decrease in accounts payable, decreases the liabilities, which increases accrual income as there is more money available to pay AP.
An increase in prepaid expenses indicates
that more cash was paid than expensed.
An increase in accrued liabilities indicates
that more expense was accrued than paid.
On February 12, 2005, VIP Publishing, Inc. purchased the copyright to a book for $15,000 and agreed to pay royalties equal to 10% of book sales, with a guaranteed minimum royalty of $60,000. VIP had book sales of $800,000 in 2005.
In its 2005 Income Statement, what amount should VIP report as royalty expense?
A royalty is an amount to be paid based on the sales of a commodity or product, in this case a book. The royalty expense is 10% of $800,000 sales ($80,000) because this amount exceeds the minimum of $60,000 that would be paid if sales were less than $600,000.
Under a royalty agreement with another company, Wand Co. will pay royalties for the assignment of a patent for three years. When should the royalties paid be reported as an expense?
In the period incurred.
Under accrual accounting, expenses are recognized when incurred. This is the point in time when obligations come into existence. The period to which specific royalty amounts relate is the period for expense recognition. Often, royalty payments occur at specified intervals that do not correspond to the period in which the royalties were earned.
A collection of note receivable from a related party would be placed in what section of the cash flow statement?
The company is lending money to the related party and lending is not a primary business activity - the fact that the loan is in the form of a note implies that it is interest bearing.
T/F: The codification is the sole source of US GAAP for nongovernmental entities.
Class Corp. maintains its accounting records on the cash basis, but it restates its financial statements to the accrual method of accounting. Class had $60,000 in cash-basis pretax income for 2002. The following information pertains to Class operations for the years ended December 31, 2002 and 2001:
AR balance was 20,000 in 2001 and 40,000 in 2002
AP balance was 30,000 in 2001 and 15,000 in 2002
Under the accrual method, what amount of income before taxes should Class report in its December 31, 2002, Income Statement?
95,000 = 60,000+20,000+15,000
Plus increase in accounts receivable (this represents sales that were not collected and thus are included in accrual income but not in cash-basis income),
Plus decrease in accounts payable (this represents payments in excess of expenses and thus causes accrual income to exceed cash-basis income),
What period of time is used to define a current asset?
The definition of a current asset uses the period "operating cycle or one year, whichever is longer."
In analyzing a company's financial statements, which financial statement would a potential investor use primarily to assess the company's liquidity and financial flexibility?
The Balance Sheet discloses the 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 near and longer 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. Much of the potential of the firm is disclosed in the Balance Sheet. It is a statement of the wealth position of the firm and allows an assessment of the relative risk of the enterprise.
Y/N: Hahn Co. prepared financial statements on the cash basis of accounting. The cash basis was modified so that an accrual of income taxes was reported.
Are these financial statements in accordance with the modified cash basis of accounting?
Under a strict cash basis of accounting, revenues and expenses are recorded only when cash is received or paid. Under a modified cash basis of accounting, certain accruals and/or deferrals are recorded for financial-statement purposes.
The most common modifications are the capitalization and amortization of long-lived assets and the accrual for income taxes (recognition of income tax expense and related liability).
Pak Co.'s professional fees expense account had a balance of $82,000 on December 31, 2001, before considering year-end adjustments relating to the following:
•Consultants were hired for a special project at a total fee not to exceed $65,000. Pak has recorded $55,000 of this fee based on billings for work performed in 2001.
•The attorney's letter requested by the auditors dated January 28, 2002, indicated that legal fees of $6,000 were billed on January 15, 2002, for work performed in November 2001, and unbilled fees for December 2001 were $7000.
What amount should Pak report for professional fees expense for the year ended December 31, 2001?
The two amounts listed in the attorney's letter should be added to the preadjusted amount of expense, but the appropriate amount of the consultant expense has been included in the preadjusted amount. The ending expense balance therefore is $95,000 ($82,000 + $6,000 + $7,000).
The $10,000 of consulting fees not yet earned should NOT be included.
Under East Co.'s accounting system, all paid insurance premiums are debited to prepaid insurance. For interim financial reports, East makes monthly estimated charges to insurance expense with credits to prepaid insurance.
Additional information for the year ended December 31, 2005, is as follows:
Prepaid insurance at December 31, 2004 $105,000
Charges to insurance expense during 2005 (including a year-end adjustment of 17,500) 437,500
Prepaid insurance at December 31, 2005 122,500
What was the total amount of insurance premiums paid by East during 2005?
Beginning prepaid balance + Premiums paid - Expense charges = Ending prepaid balance
$105,000 + Premiums paid - $437,500 = $122,500
Premiums paid = $455,000
When changing from cash basis to accrual basis, what is the general rule regarding liabilities and assets?
The general rule to convert from cash to accrual is to add the beginning liability balances and subtract the ending liability balances; also, subtract beginning asset balances and add ending asset balances.
Before 2001, Droit Co. used the cash basis of accounting. As of December 31, 2001, Droit changed to the accrual basis. Droit cannot determine the beginning balance of supplies inventory.
What is the effect of Droit's inability to determine beginning supplies inventory on its 2001 accrual basis net income and December 31, 2001, accrual basis owners' equity?
2001 net income = Overstated
12/31/01 owner's equity = No effect
Supplies expense for 2001 under the accrual method is: supplies expense = beginning supplies + purchases - ending supplies. If beginning supplies cannot be determined, then it is assumed to be zero and supplies expense is understated, causing 2001 income to be overstated. However, total supplies expense for the entire life of the business is unaffected by the inability to determine beginning supplies for 2001. Total supplies expense for the life of the business is total purchases less ending inventory in 2001. These two amounts are determinable, and thus, owners' equity at the end of 2001 can be determined.
A company has the following accrual-basis balances at the end of its first year of operation:
Unearned consulting fees $2,000
Consulting fees receivable 3,500
Consulting fee revenue 25,000
The company's cash-basis consulting revenue is what amount?
Cash-basis revenue is the amount of cash collected for the period. $25,000 of accrual-basis revenue was recognized for the period. Start with the $25,000 amount, and add the $2,000 unearned fees. This amount is not included in the $25,000 because it is not earned but was collected during the period. Subtract the $3,500 receivable, which is included in the $25,000 but was not collected. The result is that $23,500 in cash was collected ($25,000 + $2,000 - $3,500).
U Co. had cash purchases and payments on account during the current year totaling $455,000. U's beginning and ending accounts payable balances for the year were $64,000 and $50,000, respectively. What amount represents U's accrual-basis purchases for the year?
Using an equation, or a T-account, to analyze accounts payable (AP) yields accrual purchases: Beginning AP ($64,000) + Accrual purchases - Cash payments ($455,000) = Ending AP ($50,000). Solving for accrual purchases yields $441,000.
On November 1, 2005, Key Co. paid $3,600 to renew its insurance policy for three years. At December 31, 2005, Key's unadjusted trial balance showed a balance of $90 for prepaid insurance and $4,410 for insurance expense.
What amounts should be reported for prepaid insurance and insurance expense in Key's December 31, 2005, financial statements?
Prepaid insurance = $3,400
Insurance expense = $1,100
Prepaid insurance at year end is $3,400, which is the portion of the prepayment on November 1 that continues to the next three years.
Insurance expense includes three items: (1) the $90 of prepaid insurance remaining in the trial balance that has expired, (2) the $200 of insurance expense related to the November 1 purchase above ($3,600-$3,400 remaining prepaid), and (3) the expense portion of the $4,410 insurance expense amount in the unadjusted trial balance ($4,410-$3,600) = $810. This firm must have expensed the entire $3,600 November 1 purchase because it was not reflected in prepaid insurance. The difference of $810 reflects actual expense. Therefore, total insurance expense equals $1,100 = $90 + $200 + $810.
If the accrued expenses decrease during the year, would this increase or decrease the net income when comparing the cash basis NI to the accrual basis of NI?
If the accrued expenses account (a current liability, often called accrued expenses payable) decreased during the year, then a greater amount of cash was paid for those expenses than were accrued throughout the year. This would cause cash-basis net income to be less than accrual-basis net income. Cash-basis net income reflects expenses paid; accrual-basis net income reflects expenses recognized (accrued).
T/F: A deferred revenue is a liability account.
T/F: The top level of the GAAP hierarchy is the FASB Accounting Standards Codification.
There is no implied hierarchy for any sources used for GAAP.
T/F: The FASB Accounting Standards Codification presents accounting standards as an individual discrete accounting standard.
Material is organized by major area and topic. Basis for conclusions, appendices and other ancillary content are included in the Codification only if the material is considered essential to the understanding and application of GAAP.
T/F: The balance sheet is dated differently from the income statement and the statement of cash flows.
The balance sheet is a snapshot as of a particular date, whereas the IS and CF cover a period of time.
What document is typically issued as part of the due-process activities of the Financial Accounting Standards Board (FASB) for amending the FASB Accounting Standards Codification?
A proposed accounting standards update.