Final Exam Flashcards
(27 cards)
Describe the function and primary focus of financial accounting
Provide financial information to external users such as investors and creditors that is useful in decision making.
What is the difference between cash and accrual accounting
Cash Basis accounting is the measurement of cash receipts and cash payments from transaction related to goods and services. Accrual based accounting is the measurement of revenues and expenses, regardless of when cash is recieved or paid
Define general accepted accounting principles
GAAP is a dynamic set of both broad and specific guidelines that companies should follow when measuring and reporting the information in their financial statements and related notes. GAAP facilitates decision making by investors and creditors by allowing them to compare financial information among companies
Explain why establishing accounting standards is characterized as a political process
Because it affects wealth distribution and financial outcomes, leading interest groups to lobby and influence standards in their favor
Explain factors that encourage high-quality financial reporting
-Role of an auditor is to offer credibility on financial statements, express an opinion on the compliance of GAAP, and Licensed by states to provide audit services (CPA’s)
Explain the purpose of a conceptual framework
An accounting constitution that provides an underlying foundation for U.S. accounting standards which guides the selection of events to be accounted for, measurement of those events, and means of summarizing them and communicating them to interested parties. It also provides structure and direction to financial accounting and reporting
Describe the four basic functions underlying GAAP
-The economic entity assumption presumes that economic events can be identified specifically with an economic entity
-The going concern assumption anticipates that a business entity will continue to operate indefinitely
-The periodicity assumption allows the life of company to be divided into artificial time periods to provided timely information
-The monetary unit used in U.S. financial statements is the U.S. dollar
Describe the recognition, measurement, and disclosure concepts that guide accounting practice
Recognition refers to the process of admitting information into the financial statements
Measurement is the process of associating numerical amounts with the elements
Disclosure refers to the process of including additional pertinent information in the financial statements and accompanying notes
What is the general recognition criteria
- Definition. The item meets the definition of an element of financial statements.
- Measurability. The item has a relevant attribute measurable with sufficient reliability.
- Relevance. The information about it is capable of making a difference in user decisions.
- Reliability. The information is representationally faithful, verifiable, and neutral.
Understand routine economic events—transactions—and determine their effects on a company’s financial position and on specific accounts
- Routine Economic Events & Financial Impacts – Economic Events cause changes in the financial position of the company –Transactions are economic events requiring recording (sales, purchases, debt issuance) -Effects: Impact specific accounts (assets, liabilities, and equity) and overall financial position through changes to cash/ accounts receivable (sales), recognition of liabilities (loans payable ), equity adjustments (owner investments)
Describe the steps in the accounting processing cycle:
- Identify transactions (source documents: invoices, receipts) 2. Record journal entries (double entry system) 3. Post to general ledger (organize by account) 4. Prepare an unadjusted trial balance (debit/credit verification) 5. Create worksheets (error detection) 6. Record adjusting entries (accruals, deferrals) 7. Generate financial statements (Income Statement, Balance Sheet) 8. Close temporary accounts (reset revenue/ expenses balance)
Describe the four basic financial statements
Income Statement. Purpose: Shows a company’s revenues and expenses over a period of time. Key Output: Net income (profit or loss).
Balance Sheet Purpose: Presents a snapshot of a company’s financial position at a specific point in time.
Key Elements: Assets = Liabilities + Equity.
Statement of Cash Flows
Purpose: Reports cash inflows and outflows over a period, categorized into operating, investing, and financing activities. Key Focus: Cash movement, not accruals.
Statement of Shareholders’ Equity
Purpose: Shows changes in equity accounts (like common stock and retained earnings) over a period.
Key Focus: How and why equity changed (e.g., net income, dividends, stock issuance).
Explain the closing process
The closing process serves as a dual purpose (1) the temporary accounts such as revenues, expenses, gains, losses, and dividends are reduced to zero balances, ready to measure activity in the upcoming accounting period. (2) these temporary account balances are closed (transferred) to retained earnings to reflect the changes that have occurred in that account during the period
Describe the purpose of the balance sheet and understand its usefulness and limitations
The purpose is to present a snapshot of a company’s financial position—listing assets, liabilities, and equity—at a specific point in time. Its usefulness is that it 1.Shows liquidity: ability to pay short-term obligations.
2. Assesses solvency: ability to meet long-term liabilities 3.Provides insight into financial flexibility: capacity to adapt cash flows for opportunities or needs. 4. Helps investors evaluate risk and potential for future performance.
The limitations are 1. Book value ≠ Market value. Assets recorded at historical cost, not fair value. Valuable resources (e.g., employee skills, brand loyalty) are not recorded. 2. Reliance on estimates Many values depend on judgments (e.g., bad debts, warranty liabilities, asset life, pensions).
Identify and describe the various asset classifications
These current assets are listed in decreasing order of liquidity
-Cash and cash equivalents
-Short term investments
-Accounts recivable
-Inventory
-Prepaid expenses
Explain the purpose of financial statement disclosures
o provide additional information that helps investors and creditors fully understand a company’s financial condition, performance, and cash flows beyond what is shown in the basic financial statements.
Describe disclosures related to management’s discussion and analysis, responsibilities, and compensation
disclosures affirm management’s accountability for preparing accurate financial statements and maintaining internal controls. Executive compensation disclosures detail how top executives are paid and the reasoning behind their compensation, helping investors evaluate alignment with company performanceDisclosures related to Management’s Discussion and Analysis (MD&A) provide management’s insights on operations, liquidity, capital resources, off-balance sheet arrangements, and critical accounting estimates. Management responsibilities disclosures state that management is responsible for the accuracy of financial statements and internal controls, with executives required to certify the reports under the Sarbanes-Oxley Act. Executive compensation disclosures detail how top executives are paid and explain how compensation aligns with company performance and shareholder interests.
Explain the purpose of an audit and describe the content of the audit report
The purpose of an audit is to provide independent assurance that a company’s financial statements are presented fairly and in accordance with accounting standards. Auditors also evaluate the effectiveness of internal controls. The audit report communicates the auditor’s opinion on the financial statements, which can be one of four types:
Unqualified – Clean opinion, financial statements are fairly presented.
Unqualified with explanatory paragraph – Fair presentation, but additional emphasis is needed (e.g., going concern or change in accounting principle).
Qualified – Financial statements are mostly fair, but there is a specific issue.
Adverse or Disclaimer – Financial statements are not fairly presented (adverse) or the auditor cannot express an opinion (disclaimer).
Risk analysis
Comparative financial statements—financial statements are presented for the preceding year and often the previous two years
Horizontal analysis—each item is presented as a percentage of a base year amount
Vertical analysis—each item is presented as a percentage of a total
Discuss the importance of income from continuing operations and describe its components
Income from continuing operations is important because it reflects a company’s core, ongoing business performance—helping investors assess future earning potential. It includes three main components:
Revenues and gains from primary business activities,
Expenses and losses related to generating those revenues, and
Income tax expense.
Describe earnings quality and how it is impacted by management practices to alter reported earnings
Earnings quality refers to how well reported earnings reflect a company’s true, sustainable performance and how useful they are in predicting future earnings. High-quality earnings come from permanent operations likely to continue, while temporary earnings arise from unusual or one-time events. Management can affect earnings quality by using practices that inflate or smooth earnings, making financial results appear more stable or favorable than they really are—this reduces the reliability and predictive value of the reported income.
Discuss the components of operating and non operating income including the reporting on income tax expense
Operating income comes from a company’s core activities, while non-operating income includes items like interest or gains/losses from investments. Restructuring costs, incurred during company reorganizations, are recognized when obligations arise and can create long-term liabilities. Earnings quality is affected by both temporary items (like restructuring) and permanent earnings, which reflect ongoing operations. Understanding these components helps assess the sustainability and predictability of a company’s earnings.
Define what constitutes discontinued operations and describe the appropriate income statement presentation when 1) a component has been sold and 2) a component is considered for sale
Discontinued operations occur when a company sells or plans to sell a component of its business, such as an operating segment, subsidiary, or asset group, and the disposal represents a major strategic shift.
Sold or disposed of: If a component is sold, income effects are reported separately, including operating income from the beginning of the period to the disposal date and any gain or loss from the sale of assets.
Held for sale: If a component is not yet sold but is likely to be within a year, income effects are reported, along with an impairment loss if the fair value of the assets is less than their book value.
These operations are shown separately in the income statement, including income tax effects, to clearly differentiate from continuing operations, helping users assess the company’s future performance. Disclosures and reclassifications are provided for comparative purposes across reporting periods.
Understand retrospective, modified retrospective, prospective approaches and when to apply each approach
Retrospective approach. The new standard is applied to all periods presented in the financial statements. That is, we restate prior period financial statements as if the new accounting method had been used in those prior periods. We revise the balance of each account affected to make those statements appear as if the newly adopted accounting method had been applied all along.
Modified retrospective approach. The new standard is applied to the adoption period only. Prior period financial statements are not restated. The cumulative effect of the change on prior periods’ net income is shown as an adjustment to the beginning balance of retained earnings in the adoption period.
Prospective approach. This approach requires neither a modification of prior period financial statements nor an adjustment to account balances. Instead, the change is simply implemented in the current period and all future periods
