Flashcards in Financial Reporting Deck (102):
What is the primary objective of accounting?
To measure income
What is the most authoritative set of accounting pronouncements?
The FASB Codification
All pronouncements fall under the Codification umbrella
What are the 2 Levels of Authority within the FASB codification?
Authoritative and Non-Authoritative
How does managerial accounting differ from financial accounting?
Managerial Accounting has a “timeliness” focus
Managerial Accounting is not required to follow GAAP
Which financial reports are required to be filed with the SEC?
Form 10K - Annual and Audited
Form 10Q - Quarterly and Reviewed
What is the focus of financial reports for individual companies?
Focus is on the needs of users to help them make decisions and assessments about the company
Does not make assessments of the economy
What are the Primary Constraints of Financial Reporting?
Cost vs. Benefit
What are the Secondary Constraints of Financial Reporting?
Consistency - Year vs. Year
Comparability - Company vs. Company
What are the Qualitative Characteristics of Financial Reporting?
Relevance & Faithful Representation
Relevance - Makes a difference to the user
Predictive Value - Future Trends
Confirming Value - Past Predictions
Materiality - Could affect User Decisions
Completeness - Nothing omitted that would impact the decision-making of a user
Neutrality - Information is presented is without bias
Free from Error - No material errors or omissions
What are the Enhancing Qualitative Characteristics of Financial Reporting?
Comparability Verifiability Timeliness and Understandability
Comparability - Allows users to compare different items among various periods
Verifiability - Different people would reach a similar conclusion on the information presented
Timeliness - Information is made available early enough to impact the decision making of users
Understandability - Information is easy to understand
How does Conservatism affect the recording of accounting transactions?
When an estimate is necessary due to uncertainty conservatism chooses the best option that won’t overstate the financial position of the company
What is an accrual?
Earned (Revenue) or Incurred (Expense) but no Cash Receipt/Outlay yet
What is a deferral?
Cash Receipt/Outlay but not Earned (Revenue) or Incurred (Expense)
What is recognition in accounting?
When an item is recorded and included in the financial statements
Describe fair value with respect to an asset
The price you would receive if you sold the asset
Assumes asset is at its highest and best value
Assumes asset is sold at its most advantageous market to get the best price possible
What market assumptions are made in a fair value assessment?
Buyer and Seller are not Related
Buyer and Seller are Knowledgeable
Buyer and Seller are able to transact – i.e. This isn’t a hypothetical transaction for Fair Value measurement purposes. The buyer actually does have the $10M to purchase the asset you’re trying to value at $10M
Buyer and Seller are both motivated to buy/sell
What items are included in a Level 1 input in the fair value hierarchy?
Price quotes or market prices
For example NYSE or NASDAQ
What items are included in a Level 2 valuation input?
What items are included in Level 3 inputs of the fair value hierarchy?
Unobservable inputs such as assumptions or forecasts
Lowest priority for valuation
What are acceptable valuation techniques for fair value?
Market approach - uses market transactions and prices to value the asset
Income approach - uses present value discounts earnings
Cost approach - uses replacement cost to value the asset
What are current assets?
Inventory or Assets expected to be converted or consumed during a business' operating cycle
Deferred Gross Profit on Installment Sales (Contra Asset)
Receivables expected to be collected in 12 months or less
What are current liabilities?
Liabilities that will use current assets during the present operating cycle
What is an accrued liability?
Expense that has been incurred but not paid
Example: rents payable
What is a deferred revenue?
A type of current liability
Payments that have been received but cannot be recorded as revenue yet
Example: Tenant pre-pays rent – Landlord still must “perform” to earn it and is a liability until this happens
When are revenues recognized?
When they have been earned; i.e. company has performed
What is a gain?
Increase in equity from an activity or event that is not central to the main activities of the business
Can be operating or non-operating
What is a loss?
Decrease in equity from an activity or event that is not central to the main activities of the business
Can be operating or non-operating
What is an operating cycle?
Average time it takes to turn materials or services into Cash
What is the present value of future cash flows?
Valuation method - the current value of a future amount of money using a specific interest rate
What is historical cost?
How much an asset cost - (net of depreciation and amortization)
What is replacement cost?
How much it would cost to reacquire an asset today (Entrance Cost)
What is a market cost?
The sale price of an asset (Exit Cost)
What is Net Realizable Value?
Sale Price of an Asset - Selling/Disposal Fee
When is royalty income recognized? How is it recognized?
Recognized when earned
If the royalty % is applied against net sales then subtract the estimated return amount from the gross sales first and then apply the royalty rate
When is revenue recognized in an installment sale?
Revenue recognized upon receipt of cash
Only used when cash collection is uncertain
What is deferred gross profit?
Gross Profit that can’t be recognized until cash is received
D.GP = Gross Profit % x Accounts Receivable
Pay attention to the year if GP% varies
What is the cost recovery method?
No revenue recognized until all costs are recovered from purchase of the asset
Most conservative method of revenue recognition when collection of sale price is uncertain
What is subscription revenue? How is it recorded?
Payment has been received but performance is not complete.
As company performs revenue is recognized.
Recorded as a Deferred Revenue (Liability) on Balance Sheet
How are franchise revenues recorded?
Franchiser - Startup franchise fee revenue deferred until franchisee has completed substantial performance
Franchisee – Costs are deferred until corresponding revenue is recognized
How do you calculate sales revenue starting from cash basis income?
Sales (i.e. Customer Payments)
+ Ending Accounts Receivable
– Beginning Accounts Receivable
= Sales Revenue on an Accrual Basis
How do you calculate COGS starting from Cash Basis?
Cash Remitted (i.e. paid)
+Increase in Accounts Payable
–Increase in Inventory
=COGS on an Accrual Basis
How are discontinued operations reported? When are they used?
Reported Net of Tax after Continuing Operations but before Extraordinary Items
Company decides to cease operating a segment of its business
Includes Income (or loss) from the period plus the gain (or loss) from disposal
What qualifies as an extraordinary item? How is it recorded?
Both unusual AND infrequent
Reported Net of Tax after Discontinued Operations
Note: Usual *or* Infrequent Items are reported as part of Continuing Operations
What is constant dollar accounting?
Adjusts assets to reflect a consistent level of purchasing power due to inflation
Uses the Consumer Price Index (CPI)
When are expenses recognized?
When they are incurred. Accrue if not yet paid.
What are accrued expenses?
Those incurred but not paid.
Product costs - Expenses should be matched with associated revenues as they are recognized (sales commission on a used car sale)
Period costs - Expenses amortized and recognized with the passage of time
When should impaired assets be written down to fair value and expensed?
What major items should be classified under General & Administrative (G&A) expenses?
Office staff salaries
Note: Sales staff salaries and portions of the building assigned to Sales should be allocated to Selling Expense not G&A
What are business start-up costs?
One-time costs for opening a new business
Expensed as they are incurred
When is interest *not* expensed?
Interest on projects (software) for internal use is not expensed but is instead capitalized
What are the major components of comprehensive income?
Net Income + Other Comprehensive Income (OCI):
Cumulative accounting adjustments
Non-owner changes in equity
What items are considered cumulative accounting adjustments?
Foreign Currency Translation Adjustments
Unrealized gains on AFS Securities
Minimum Pension Liability adjustment for defined benefit plans
What is the purpose of a reclassification adjustment?
Avoids double counting items that were included in both Net Income and OCI
Example: AFS Securities previously included in OCI are now sold at a loss and reported on the Income Statement
Where is comprehensive income reported?
Reported in Stockholder’s Equity on Balance Sheet or in a Statement of Income and Comprehensive Income
Note: Earnings Per Share is not required for OCI
What disclosures on accounting policies are required in financial statements?
Accounting Principles used
Basis of Consolidation
Inventory Pricing Methods
Amortization of Intangibles
What are some major risks and uncertainties that must be disclosed?
Nature of Operations
Use of Estimates and listing of Significant Estimates
Costs associated with Intangibles that are specifically identifiable CAN be capitalized. Examples?
Internally developed Intangibles should be expensed against income; US GAAP does not allow capitalization of R&D costs.
1) Legal fees and other costs related t a SUCCESSFUL defense of the asset
2) Registration or consulting fees
3) Design costs
4) Other direct costs to secure the asset
IFRS: Research and Internally Developed Intangibles must be expensed, but intangibles from development are recognized if the entity can demonstrate what?
All of these:
1) Technological feasibility
2) Entity intends to complete the Intangible
3) Entity has ability to sell or use intangible
4) Intangible will generate future economic benefit
5) Adequate resources available to complete devlopement and sell/use the asset
How is a patent amortized?
Over the shorter of its estimated life or remaining legal life
Goodwill is not amortized but rather...
tested for impairment annually
When would you write off the entire remaining cost to expense of an Intangible Asset?
If it becomes worthless during the year (due to technological obsolescence or due to an unsuccessful patent defense lawsuit)
What do you do if an Intangible Asset is impaired?
Write down the intangible asset and recognize an impairment loss
Valuation - GAAP vs IFRS
GAAP: Finite intangible assets are reported at cost less amortization and impairment. Indefinite intangible assets are reported at cost less impairment.
IFRS: Cost model or Revaluation model
Cost: Recorded at cost adjusted for amortization and impairment
Revaluation: Asset revalued regularly...Revaluation model carrying value = Fair value on revaluation date - subsequent amortization - subsequent impairment
What are Revaluation Losses and how are they recorded?
FV on revaluation date < Carrying Value
Reported in IS..unless...
loss reverses previous revaluation gain --> recognized in OCI and reduces the revaluation surplus in Acc OCI
What are Revaluation Gains and how are they recorded?
FV on revaluation date > Carrying Value
OCI and accumulated in equity as revaluation surplus
IS to extent they reverse revaluation loss
Start-up costs do not include what?
1) Routine, ongoing efforts to refine, enrich, or improve the quality of existing products, services, processes, or facilities
2) Business mergers and acquisitions
3) Ongoing customer acquisition
How do you Calculate Goodwill (2 ways)
1) Acquisition Method:
Goodwill = excess of acquired entity's FV over FV of the entity's net assets, including identifiable intangible assets
2) Equity Method:
Goodwill = the excess of capital stock purchase price over FV of net assets acquired
How do you amortize Capitalized Software Costs?
1) % of sales = Total capitalized amount X (current gross revenue for period / total projected gross revenue for product)
2) Straight line
What is the Impairment 2 step approach?
Step 1 - Carrying amount of the asset is compared to the sum of the undiscounted future net cash flows
Step 2 - If carrying amount exceeds total future net cash flows, asset is impaired and an impairment loss equal to the difference between the carrying amount of the asset and the FAIR VALUE us recorded
Where do you record an Impairment Loss?
IS as a component of income from continuing operations. Carrying amount of asset is reduced by the impairment loss.
IFRS Impairment loss
1 step model...CV compared to asset's recoverable amount.
Recoverable amount = greater of FV less costs to sell and asset's value in use.
Value in use = PV of future CFs
Installmant Sales Formulas
1) Gross Profit = ?
2) Gross Profit % = ?
3) Earned Gross Profit = ?
4) Deferred Gross Profit = ?
Gross Profit = Sale - COGS
Gross Profit % = Gross Profit / Sales Price
Earned Gross Profit = Cash Collections X Gross Profit %
Deferred Gross Profit = Installment Receivable X Gross Profit %
Ho are exchanges having commercial substance recorded?
FV of assets given up are assumed to equal the FV of assets received, including any cash given or received.
How do you account for Gains and Losses when nonmonetary exchanges have commercial substance.
Gains and losses are expensed IMMEDIATELY
Under GAAP how do you determine Functional Currency for FS Translation?
If the currency is the currency of the primary economic environment in which the company operates and
1) The foreign operations are relatively self-contained and integrated within the country
2) Day-to-day operations do not depend on the parent's or investor's functional currecny
3) Local economy of foriegn entity is NOT highly inflationary (cumulative 100% over 3 years)
FS of Foreign subsidiary are not in the subsidiary's functional currency must be remeasured to the functional currency.
Start with BS: Monetary @ year end
Nonmonetary @ historical
IS: @ weighted average
Historical for BS related accounts
Remeasurement G/L (income statement): Plug "Currency G/L" to get net income to the required amount needed to adjust retained earnings in order to make the balance sheet balance
OCI items include the following:
1) Pension Adjustments
2) Unrealized G/L from available for sale securities
3) Foreign Currency Items
4) Effective Portion of Cash Flow Hedges
5) Revaluation Surplus (IFRS only)
Translation Method (Functional/normal)
FS of foreign subsidiary are in sub's functional currency, FS are translated to reporting currency
Start w/ IS: @ weighted average
BS: @year-end rate
C/S and APIC @ historical
Roll forward R/E
Translation G/L (OCI): Plug "translation adjustment" to other comprehensive income.
Reported at FV
Unrealized G/L = I/S
Cash Flow = Operating/Investing
Reported at FV
Unrealized G/L = OCI (PUFE)
Cash Flow = Investing
Reported = Amortized Cost
Unrealized G/L = NONE
Cash Flow = Investing
1) From Trading
2) To Trading
3) HTM --> AFS
4) AFS (debt securities) --> HTM (debt securities)
1) Unrealized G/L already recognized in earnings--> do NOT reverse
2) Unrealized G/L on date of transfer--> recognized in earnings on IS
3) Unrealized G/L on date of transfer --> OCI
4) Amortize G/L from OCI w/ any bond discount/premium amortization
What if decline in FV of HTM or AFS securities?
Write down security to FV and write down is a Realized Loss on IS (GAAP)
(IFRS) Impairment Loss recognized on IS and security written down by 1) reducing cost or 2) using valuation allowance...previously recognized impairment loss MUST BE REVERSED w/ reversal amount recognized on IS
What is the journal entry for selling TRADING securities?
DR Cash XXX
CR Trading Security XXX
CR Realized G on Trading Security XXX
What is the journal entry for selling AFS securities?
DR Cash XXX
DR Unrealized G on AFS (PUFE) XXX
CR AFS Security XXX
CR Realized G on AFS security (IDEA) XXX
When do you use:
1) Cost Method
2) Equity Method
1) Cost Method = 50% ownership and significant influence
Cost Method - How is "Investment in Investee" affected?
- Investment in Investee is NOT adjusted for investee earnings
- Investment in Investee is adjusted to FV
- Cash dividends from the investee are reported as Income by the investor (Parent)
Equity Method - Investment in Investee
Like a Bank Account
B - Beginning Balance
A - Add: Investor's share of investee's earning (like bank interest; it is income when earned, not when taken out)
S - Subtract: Investor's share of investee's dividends (like bank withdrawals; and it is not income)
E - Ending Balance
Difference between Purchase Price and NBV of investee's net assets.
NB - FV = difference amortized over useful life
DR. Equity in Investee Income
Cr. Investment in Investee
Purchase Price - FV = Goodwill (Not Amortized or Impaired)
Why would you switch from Cost to Equity Method and what do you do to adjust?
Switch to Equity Method when significant influence is acquired or 20%-50%.
Periods that used the Cost Method are retrospectively adjusted.
- Apply Equity Method to prior period's old %
- Do NOT apply new % to prior period --> did NOT own that % back then.
- C/S, APIC, R/E is eliminate by DR (eliminates sub's equity)
- Investment in sub eliminated by CR
- Non-controlling Interest (NCI) created by CR if not 100% owned by Parent
- B/S (100% Assets/Liab) adj. to FV by DR
- Identifiable Intangibles of sub recorded @ FV w/ DR
- If FV of sub (Acquisition cost + NCI) > FV of sub's Net Assets = Goodwill --> DR
- If FV of sub < FV of sub's Net Assets = Gain --> CR
What are the major components of the Income and Retained Earnings Statement?
(I) Income from continuing operations (Gross and net of tax)
(D) Discontinued operations (Net of tax)
(E) Extraordinary items (net of tax)
(A) effect of Accounting principle change (retained earning statement)
How are the following business combination costs treated?
1) Direct out-of-pocket costs (legal fees, finder's fees)
2) Stock registration/SEC filing fees ...
3) Indirect costs
4) Bond issue costs
1) DR - EXP
2) DR - APIC
3) DR - EXP
4) DR Bond Issue Costs
BS presentation of NCI:
1) At Acquisition Date
2) After Acquisition Date
1) FV X NCI % = NCI --> In consolidated equity
2) (Like the Equity Method) -->BASE
+ NCI share of sub's NI
- NCI share of sub's dividends
= End. NCI
IS presentation of NIC:
- Include 100% of sub's Rev/Exp (after acquisition date)
- IS separately show consolidated NI and NI from NCI.
Sub's Income - Sub's EXP = Sub's NI
Sub's NI X NCI % = NI attributable to NCI
How can you account for Acquisition of Goodwill under GAAP/IFRS?
Full Goodwill Method (GAAP/IFRS)
Goodwill = FV of sub - FV of sub's Net Assets
Partial Goodwill Method (IFRS)
Goodwill = Acquisition Cost - FV of sub's Net Assets acquired
$100,000 in sales w/ discount 2/10, n/30 - Show Journal Entries for:
1) Gross Method
2) Net Method
Accounts Receivable 100
If within discount period:
Sales Discount Taken 2
Accounts Receivable 100
If not within discount period:
Accounts Receivable 100
If w/in discount period:
If NOT w/in discount:
Sales discount not taken 2
Direct Write-Off Method of estimating uncollectible A/R
- NOT GAAP
- used for Tax purposes
- account written off and bad debt recognized when the account becomes uncollectible
J/E when account is determined uncollecible:
Dr. Bad Debt Exp XXX
Cr. A/R XXX
Allowance Method of estimating uncollectible A/R
- based on past experience
3 acceptable methods to estimate uncollectible or doubtful accounts
1) % of Sales Method (IS approach)
2) % of A/R at year-end Method (BS approach)
3) Aging of Receivables Method (BS approach)
How is Inventory recorded under GAAP/IFRS?
GAAP - Cost unless sold at a loss, then Lower of Cost and Market
IFRS - Cost unless sold at a loss, then Lower of Cost and NRV
How do you determine Lower of Cost and Market?
Middle value of Replacement Cost (Market), Market Ceiling and Market Floor.