Overview-FAR
I. Accounting Environment
A. Financial Accounting
-Function is to provide quantitative information, primarily financial in nature, about economic entities that is intended to be useful in making economic decisions-in making reasoned choices among alternative courses of action
-The most important criterion to meet in a financial statement presentation is that the information provided be useful for decision making
B. Underlying Environmental Assumptions
-Economic Entity-In order to properly report those economic events affecting an entity, the specific economic entity must be defined and separated from other entities
-Going Concern-Liquidation accounting, characterized by the use of net realizable values rather than historical costs, is then employed
-Unit-of-Measure-Monetary units are used for the measurement and reporting of economic activity
-Periodicity-Providing financial accounting information on a periodic, timely basis
C. Basic Accounting Principles
-Historical Cost-Assets acquired, as well as liabilities incurred by an enterprise, are recorded at cost
-Revenue Recognition-Revenue generally is recognized when 1) the earnings process is complete and 2) an exchange has taken place (revenue generally recognized at point of sale).
-Matching-All expenses incurred in generating the revenues for a period must be recognized in that same period
-Objectivity-Accounting data should be both a) objectively determined and b) verifiable
-Materiality-Cost-benefit relationship of additional accuracy
-Consistency-Consistency in the application of accounting principles also prevents income manipulation by management
-Full Disclosure-Financial statements should be presented in a manner that will reasonably assure complete and understandable communication of all relevant accounting information useful for decision making
-Conservatism-Treatment should be that which understates rather than overstates income or net assets
D. Accounting Model
-Financial Position-Reported by means of a Balance Sheet
-Results of Operations-Report the relative success of the profit-directed activities of the entity. Formally represented by the income statement and statement of changes in comprehensive income
-Statement of Cash Flows-Cash flow from operating activities +- Cash flow from investing activities +- cash flow from financing activities=change in cash. It reports the net cash provided or used by operating, investing, and financing activities, and the aggregate effect of those flows on cash during the period
II. Financial Position-The Balance Sheet
A. Format
-Assets-probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events. Classified in order of liquidity.
1. Investments-Assets held for control, appreciation, regular income, or a combination of the three
2. Valuation Accounts-Reductions or increases in an asset account to reflect adjustments beyond the historical cost or carrying amount of the asset
-Liabilities-probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events
1. Current liabilities require the use of existing assets, long term involve existing assets or creating liabilities
2. Valuation Accounts
-Owners’ Equity-Residual interest in the assets of an entity that remains after deducting its liabilities
1. Contributed Capital-Par or stated value represents the minimum legal required capital as determined by articles of incorporation and state law. Additional paid-in capital reflects the amount received in excess of the par value
2. Retained Earnings-Accumulated earnings less losses and dividends
3. Accumulated OCI-Required adjustments are needed for unrealized gains and losses on AFS securities
B. Valuation
-Assets
1. Historical Cost-Valued at acquisition cost less depreciation or amortization.
2. Replacement Cost-Used in the primary financial statements only where the utility of inventory items has diminished
3. Price-Level Adjusted-Historical cost adjusted to reflect inflation
4. Discounted Cash Flows-Valuation of assets in terms of net present value of the future benefits associated with the ownership of the asset. Notes Receivable and bond investments are valued at present value upon acquisition
C. Off-Balance-Sheet-Risk-Risk of accounting loss from a financial instrument that exceeds the amount recognized for the instrument in the balance sheet.
III. Reporting of Operations-Income Statement
A. Elements
-Revenues: inflows or enhancements of assets of an entity or settlement of liabilities during a period from delivering activities that constitute the entity’s ongoing major or central operations
-Expenses: outflows of assets or incurrence of liabilities that constitute the entity’s ongoing operations during a period. Recognize expenses in accordance with one of three principles:
1. Cause and Effect-Costs are directly related to specific revenue (COGS)
2. Systematic and Rational Allocation-Costs allocated among the periods benefited
3. Immediate Recognition-Costs that are deemed to provide no discernible future benefits are expensed as incurred
-Gains are Losses-increases in equity from peripheral or incidental transactions of an entity and from all other transactions and other events and circumstances affecting the entity during a period except those that result from revenues or investments by owners
-RE Statement-Beginning Balance +- Prior period adjustments + NI –Dividends =Ending Balance
IV Statement of Comprehensive Income
A. Description-Change in equity of a business enterprise during a period from transactions and other events from nonowner sources. Over the life of a business will equal the net difference between cash receipts and outlays. Divide comprehensive income into NI and Other Comprehensive Income. OCI is revenues, expenses, gains, and losses that are included in Income, but excluded from Comprehensive Income
B. Format-Report in statement of income and comprehensive income, statement of income and separate statement of comprehensive income, and a statement of changes in equity
-Classification-Classify by their nature: foreign currency items, minimum pension liability adjustments, unrealized gains and losses on certain investments in debt and equity securities, and certain gains and losses on hedging
-Accumulated balance of OCI-Entities must display the accumulated balance of OCI separately from RE and Additional PIC in the equity section of a statement of financial position
V. Statement of Cash Flows
A. Description-Must be issued when a balance sheet and Income Statement are issued. Noncash investing and financing transactions are not reported in the statement of cash flows. Only show the effects of operating, investing, and financing activities that are directly related to cash flows
B. Format
-Under the direct approach, operating cash payments are deducted from operating cash receipts, effectively resulting in a cash basis income statement. The indirect approach converts NI to net cash flow from operating activities by adding back noncash charges in the income statement to NI and subtracting noncash credits from NI
VI. Statements of Financial Accounting Concepts
A. Objectives
-Set forth objectives and fundamentals that will be the basis for future development of financial accounting and reporting standards
B. Objectives of Financial Reporting by Business Enterprises
-Limitations-Based on estimates
-Benefits vs Cost
-Needs of Users-Primarily stem from needs of external users
-Decision Making-Enable financial reports to aid others in making sound economic decisions
-Scope of Information-Provide Info on an enterprise’s economic resources, obligations, and Owners’ Equity
-Management Performance-Info concerning the performance of management in guiding the enterprise
C. Qualitative Characteristics of Accounting Information
-Usefulness-Info should be relevant and reliable
-Relevance-info is relevant if it is capable of making a difference in a decision by helping users to form predictions about the outcomes of past, present, and future events or to confirm or correct prior expectations. Info has predictive value if it helps users increase the likelihood of correctly forecasting the outcome of past or present events. Info has feedback value if it enables users to confirm or correct prior expectations
-Reliability-increased when the info is both verifiable and neutral. Info is verifiable when a large number of independent observers derive similar results when using the same measurement methods. Info is neutral when the info is free from bias towards a predetermined result
-User-Specific Factors-It is virtually impossible to provide information that will completely satisfy the needs of all users; thus, the information provided usually represents a compromise among the perceived needs of the various users
D. Recognition and Measurement in Financial Statements of Business Enterprises
-Maintenance Concepts: Under the financial capital concept, if the effects of price changes are recognized, they are reported as holding gains or losses (included in income). Under the physical capital concept, such changes are considered adjustments to equity
-Financial Capital-Return on financial capital results only if the financial amount of an enterprise’s net assets at the end of a period exceeds the corresponding amount at the beginning of the period, after excluding the effects of transactions with owners
-Physical Capital-Return on physical capital results only if the physical productive capacity of the enterprise at the end of the period exceeds its capacity at the beginning. Thus, the physical capital concept can be implemented only if the enterprise’s productive assets, inventory, etc. are measured at their current cost
-Recognition-An item must be an element of financial statements, measurable, relevant, and reliable to be recognized
-Revenues and gains-Recognized when they are both realized and earned
-Expenses and Losses-Recognized if a consumption of economic benefits or if future economic benefits of assets have been reduced or eliminated, or that liabilities have been incurred or increased
E. Elements of Financial Statements
-10 total elements. 7 are on both business and Not For Profit organizations (assets, liabilities, equity or net assets, revenues, expenses, gains, and losses) and 3 are for business only (owner’s investment, distributions to owners, and comprehensive income)
-Accrual Accounting-Attempts to record the financial effects of an entity’s transactions in the period in which they occur rather than only when cash is received or paid by the entity.
-Allocation-Accounting process of assigning or distributing an amount according to a plan or formula
-Realization-Process of converting noncash resources and rights into money
-Recognition-Process of formally recording or incorporating an item in the financials of an entity
-Period Costs-Costs usually recognized as expenses in the period incurred (administrative salaries, store utilities)
-Cost Allocation-Costs that yield their benefits over two or more periods of time
F. Using Cash Flow Information and Present Value in Accounting Measurements
-In the absence of observed transaction prices measurements should attempt to capture the elements that taken together would comprise a market price if one existed
VII. Authority of Pronouncements
-Committee on Cooperation with Stock Exchanges (1932-34)-made a series of recommendations, which were later adopted by the AICPA
-Committee on Accounting Procedure and Accounting Research Bulletins (1939-59)-Objective was to narrow the areas of difference and inconsistency in the accounting profession
-APB (1959-1973)-Issued 31 Opinions and 4 statements. Opinions were requirements, statements were recommendations
-FASB (1973-Present)-Promulgations have same authority as the APB opinions, but are known as Statements of Financial Accounting Standards
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