Faygie Soloveitchik

Intermediate Accounting- Midterm Review

Contents
Chapter 1- Financial Accounting and Accounting Standards ..................................................................... 2 Financial Accounting ............................................................................................................................ 2 Objective of Financial Reporting .......................................................................................................... 2 Setting Standards ................................................................................................................................. 2 Challenges to Financial Accounting ...................................................................................................... 2 Chapter 2- Conceptual Framework for Financial Reporting ...................................................................... 3 Objective ............................................................................................................................................. 3 Qualitative Characteristics ................................................................................................................... 3 Basic Elements ..................................................................................................................................... 3 Recognition and Measurement Concepts ............................................................................................. 4 Chapter 3- The Accounting Information System ....................................................................................... 5 Basic Terminology................................................................................................................................ 5 Accounting Cycle.................................................................................................................................. 5 Adjusting Entries .................................................................................................................................. 5 Closing Process .................................................................................................................................... 5 Review all financial statements. ........................................................................................................... 5 Chapter 4- Income Statement and Related Information ........................................................................... 6 Usefulness of the Income Statement.................................................................................................... 6 Limitations of the Income Statement ................................................................................................... 6 Format of the Income Statement ......................................................................................................... 6 Reporting Irregular Items ..................................................................................................................... 6 Special Reporting Issues....................................................................................................................... 7

Faygie Soloveitchik

Intermediate Accounting- Midterm Review

Chapter 1- Financial Accounting and Accounting Standards

Financial Accounting
y y Culminates in preparing financial statements for both internal and external parties. Financial statements: 1. Balance sheet 2. Income statement 3. Statement of cash flows 4. Statement of owners/stockholders equity

Objective of Financial Reporting

y y y Entity perspective- Corporation is separate and distinct from owners. Decision usefulness. Accrual basis accounting matching principle.

Setting Standards
y GAAP- generally accepted accounting principles o SEC  Federal agency.  It requires registrants to adhere to GAAP.  The SEC relies on GAAP to develop accounting standards. Companies on stock exchange must submit financial statements to SEC.  They help ensure integrity of public companies. o AICPA  Committee of accounting procedures. o FASB  FASB statements are considered GAAP.  They improve and establish standards of accounting for the guidance and education of the public.  FASB Codification- one place for GAAP principles to simplify to the user. o IFRS- nationally accepted accounting principles.

Challenges to Financial Accounting

y y y y Nonfinancial measurements- failed to provide some jey performance measures widely used by management. Forward looking information- failed to provide forward looking information which would be used by creditors and potential investors. Soft assets-failed to provide information about intangibles. Timeliness- done quarterly and provided audited financials annually. Little real time information available.

Faygie Soloveitchik

Intermediate Accounting- Midterm Review

Chapter 2- Conceptual Framework for Financial Reporting

Objective
y To provide financial information that is useful to present and potential investors, lenders and creditors.

Qualitative Characteristics
y Fundamental Qualitieso Relevance Predictive value- must be capable of making a difference in decision.  Confirmatory value- confirms or corrects prior expectations.  Materiality- company specific aspect of relevance- relevant to influencing decisions. It requires evaluating relative size and importance. o Faithful representation- numbers and descriptions have to match what happened.  Completeness- all information that is necessary for faithful representation is provided.  Neutrality- information must be unbiased.  Free from error- must be accurate. Nothing can be totally free from error, i.e. bad debts expense. Enhancing Qualitieso Comparability- measured and reported in a similar manner for different companies.  Consistency- applying the same accounting treatment to similar events from period to period. o Verifiability- when independent measurers using the same methods obtain the same results. o Timeliness- having information available before it loses its capacity to influence decisions. o Understandability- quality of information that lets reasonably informed users see its significance.

Basic Elements
y y y y y y y y Assets Liabilities Equities Investments by Owners- increase in assets and equity Distribution to Owners- decrease in assets and equity Comprehensive Income- changes in assets and equity from non-owner sources. It s basically changes to equity besides investments by owners and distribution to owners. Revenues- inflows or enhancements of assets through ongoing central operations. Expenses- Outflows, using up assets or incurring liabilities through ongoing central operations.

Faygie Soloveitchik

Intermediate Accounting- Midterm Review

y y

Gains- Increases in equity from transactions and other events except those that result from revenues or investments by owners. Losses- Decrease in equity from transactions and other events except those that result from expenses or distribution to owners.

Recognition and Measurement Concepts

y Basic Assumptions o Economic entity- activities are separate and distinct from owners. o Going concern- the company will have a long life. Depreciation and amortization policies are only justifiable if permanence is assumed. o Monetary unit- money is common denominator of economic activity. It must be relevant, simple, universal, understandable and useful. o Periodicity- a company can divide its activities into artificial time periods. This provides an example of tradeoff between relevance and faithful representation. Principles o Measurement Historical cost- generally thought to be verifiable.  Fair value- the price that would be received to sell and asset or paid to transfer a liability at the measurement date. o Revenue recognition- revenue is recognized when realized and when earned.  Exceptions: a. During production- before job is completed in long term contracts. b. At end of production but before sale takes place- mine and agricultural products. c. Upon receipt of cash- when collection is uncertain at time of sale. Generally though, revenue should be recognized at time of sale and bad debts are recorded as separate estimates. o Expense recognition- matching expenses with revenues.  Product costs are recognized when matched with revenue, but period costs are expensed as incurred. o Full disclosure- information in statements has to make a difference to decisions, and be understandable. A reasonably prudent investor should not be misled. Constraints o Cost constraint- costs of information must be weighed with its usefulness. o Industry practice- nature of some businesses can require departure from the basic theory.

Faygie Soloveitchik

Intermediate Accounting- Midterm Review

Chapter 3- The Accounting Information System

Basic Terminology
y y y Real and nominal accounts- balance sheet accounts are real, nominal accounts are revenue, expenses, and dividends. General ledger- book containing all accounts. Closing entries- all nominal accounts are reduced to zero.

Accounting Cycle
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. y Identification of transactions and events Journalization Posting Trial balance Adjustments Adjusted trial balance and worksheet Statement preparation- income statement, balance sheet, retained earnings, cash flows. Closing- nominal accounts Post closing trial balance (optional) Reversing entries (optional) The cycle is repeated each period.

Adjusting Entries
y Deferrals o Prepaid expenses o Unearned revenue Accruals o Accrued revenues o Accrued expenses- interest, rent, taxes, salaries

Closing Process
1. All revenue and expense accounts are closed to income summary which represents net income/net loss. 2. Income summary is closed to retained earnings. 3. Dividends are closed to retained earnings.

Review all financial statements.

Faygie Soloveitchik

Intermediate Accounting- Midterm Review

Chapter 4- Income Statement and Related Information

Usefulness of the Income Statement
1. Evaluate past performance. 2. Provide a basis for predicting future performance. 3. Help assess the risk or uncertainties of achieving future cash flows.

Limitations of the Income Statement

1. Companies omit items that can t be measured reliably, i.e. brand recognition, customer service. 2. Income numbers are affected by accounting methods employed. 3. Income measurement involves judgment

Format of the Income Statement

y y y Income statement includes revenues, expenses, gains and losses. Single step income statement- revenue-expenses=net income. Multiple step income statement (pg. 166) o Separation of operating and non-operating activities o Classification of expenses by functions such as merchandising (COGS), selling and administration. o Sections:  Operating section y Sales or revenue section y Cost of goods sold section y Selling expenses y Administrative or general expenses  Non-operating section y Other revenues and gains y Other expenses and losses  Income tax  Discontinued operations  Extraordinary items  Earnings per share o Three subtotals  Net sales  Gross profit  Income from operations o Condensed income statement- includes only totals of groups and supplementary schedules. (pg. 167)

Reporting Irregular Items

y Discontinued operations o Report gains or losses of disposal of a component of a business. 6

Faygie Soloveitchik

Intermediate Accounting- Midterm Review

When gains or losses on discontinued items occur, companies use the phrase Income from continuing operations before these items. o Listed between income from operations and net income on the income statement. Extraordinary items o They are distinguished by their unusual nature and infrequency of occurrence. o Rarely does an event meet the criteria. o Environment must be considered. o It is listed on the income statement net of taxes, right before net income. Unusual gains or losses o Unusual or infrequent items but not both. o They are listed before income from operations. o NOT reported net of tax. Changes in accounting principle o Retrospective adjustments- recast the prior years statements. o Shown net of tax. Changes in estimates o Not changed retrospectively- not carried back to previous years. o Not considered errors or extraordinary items. o Change in current year s income in the appropriate accounts. Corrections of errors o Prior period adjustments- reported in year discovered as an adjustment to beginning balance of retained earnings. o

 All irregular items are shown net of tax, besides unusual gains or losses.

Special Reporting Issues

y y Intra-period tax allocation- let the tax follow income . Taxes are allocated with each irregular item. Earnings per Share= net income-preferred dividends/weighted average of common shares outstanding. o EPS must be disclosed on an income statement. Retained earnings statement- reconciles the original retained earnings if there were errors in previous periods. o Appropriated retained earnings- restricted retained earnings. This is disclosed in notes to financial statements. Comprehensive income- changes in equity except resulting from investments and distributions to owners. Other comprehensive income- non owner changes in equity that bypass the income statement. o Second income statement for comprehensive income- first thing listed is net income from regular income statement. o Combined income statement is good because only requires one statement but not as clear because net income is a subtotal. Statement of stockholders equity- columnar format. On the balance sheet, accumulated comprehensive income is listed in Stockholder s Equity. 7

y y

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