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CHAPTER 2 INTERMEDIATE ACCOUNTING 1
Relevant or Faithful: Information that is neutral Faithful Relevant or Faithful: Information that has decision making implications because of its predictive value Relevant Relevant or Faithful: Information that is complete Faithful accounting Relevant or Faithful: Information that is free from errorFaithful accounting Relevant or Faithful: Information that has decision-making implications because of its confirmatory value. Relevant Fundamental Characteristics -Relevant -Faithful representation Enhancing Characteristics -Comparable -Timely -Understandable -Verifiable -Consistency
Define NeutralInformation is free from bias in both selection and presentation of financial data. Define Complete Includes all information that is necessary for the user to understand the underlying economic event being depicted Define: Free From Error Information should not contain errors or omissions in the description of the economic event and there are no errors in the process used to produce the financial information Define Verifiability Different knowledgeable parties could reach a consensus that a particular depiction is a faithful representation Define Understandable Information is classified, characterized, and presented clearly Define Timely Information is available ti financial statement users soon enough to be useful. 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 Equity The net assets are the residual interest in the assets of an entity that remains after deducting its liabilities.
Fundamental Characteristic and Attribute? A company discloses the write-off of an accounts receivable. The receivable due from a major customer accounts for 35% of the company's current assets. Fundamental Characteristics: Relevance Attribute: Materiality Fundamental Characteristic and Attribute? A financial analyst computes a company's five-year average cost of goods sold in order to forecast next year's profit margin Fundamental Characteristic: Relevance Attribute: Predictive Value Enhancing Characteristic and Satisfied/Unsatisfied? Auditors from two offices of a large public accounting firm agree on the measurement used for a client's plant assets EC: Verifiability Satisfied Enhancing Characteristic and Satisfied/Unsatisfied?
The Later Than Sooner Company reports income only every two years. EC: Timeliness Violated Enhancing Characteristic and Satisfied/Unsatisfied? Gladys Groceries reports its investments at cost while the other companies in the grocery industry use the fair value option to measure investments EC: Comparability Violated Enhancing Characteristic and Satisfied/Unsatisfied? Grant Company engages in complex business transactions. These events are properly classified, characterized, presented clearly, and fully disclosed EC: Understandability Satisfied Define Conceptual Framework sets forth theory, concepts, and principles to ensure that accounting standards are coherent and uniform. Define Predictive Value if decision makers can use it as an input into processes that help forecast future outcomes. Define Faithful representation indicates whether financial information depicts the substance of an economic event in a
Define Relevant if it is capable of making a difference in decision making by exhibiting the following attributes: predictive value, confirmatory value and materiality. Going Concern Assumption - the entity is assumed to continue indefinitely (We are going to stay in business forever) -the basis of recording financial elements is historical accounting
- liquidation accounting is not applied unless so indicated -permits the use of accrual accounting (This is what allows this to happen) ASU 2014-15: Presentation of Financial Statements: Going Concern (Subtopic 205-40) What did it do? "FASB defines management's on going concern responsibilities"
- The standard provides new guidance to evaluate whether there is a substantial doubt about the organization's ability to continue as a going concern or provide disclosures in the footnotes.
- Is the business going to close soon and when should they nolonger operate under the assumption that the they will last forever. ASU 2014-15 (205-40) What did it say? -When statements are issued, management is required to evaluate the probability the
entity will not be able to meet its obligations as they become due within one year after the financial statements' date -If there is substantial doubt of the entity's ability to continue, management must disclose whether it has plans to alleviate the doubt -If Management's plans do not alleviate substancial doubt, it is required to include a statement in the footnotes indicating that there is substancial doubt of its ability to continue as a going concern ASU2014-15 (205-40) What must the entity disclose? - pg 79 Economic Entity Assumption -the economic entity can be identified with a particular unit of accountability -the business is separate and distinct from its owners -Entity's assets and other financial elements are not commingled with those of the owners -The economic entity assumption is an accounting concept, and not a legal construct -Departments or divisions of an entity may be considered separate entities. Proprietorship The bank can take everything you own - Unlimited Liability Partnership - Unlimited Liability
Cost/benefit rule? -The cost of providing information should not outweigh the benefit dervived -Costs and benefits are not always obvious or quantifiable -sound judgement must be used in providing information Other contraints exist but are no long explicit
- Materiality (threshold recognition) - Now a component of relevance -Conservatism
- Industry practices: each industry may handle things a different way. Conservatism when alternative accounting treatments exist, choose the one least likely to overstate assets and understates liabilities. What is the concept? Katia Clothing, a U.S. GAAP reporter, purchased land five years ago and recently had it appraised for $65,000. The company reported this amount on its most recent balance sheet Historical Cost concept What is the concept? Edward McCormick owns two separate businesses: EMC Enterprises and Edward Associates. McCormick regularly pays the property taxes for EMC from the checking account of Edward Associates Business entity concept
COncept? US Motors Inc. recently decided to recall 400,000 vehicles for a safety concern. US Motors did not report this information in its annual report Full disclosure, materiality, completeness Concept? Abare Company purchased new equipment for $2,500,000 and charged it to operating expenses on its most recent income statement. Expense recognition concept Concept? Beeke Brothers Incorporated decided not to report its quarterly results to its shareholders. Timeliness Accrual Accounting -Revenue is recognized when realized or realizable and earned (revenue recognition principle) -Expenses are recognized when incurred to match revenues (the matching principle) Cash Basis - revenue is recognized when the cash is received -expenses are recognized when cash is paid
