Exam 1 Material Combined

Review for Exam 1
25 multiple choice questions and 4 problems covering the material in units 1-4 Topic Accrual Accounting What to Know Be able to state a given transaction for cash-basis or accrual-basis accounting. Understand advantages of accrual-basis accounting Be able to adjust from accrual-basis to cash-basis accounting and vice versa. Appendix 3A (Page 195) Most companies use accrual-basis accounting Recognize revenue when it is earned and Expenses in the period incurred Without regard to the time of receipt or payment of cash Under the strict cash-basis, companies Record revenue only when they receive cash, and Record expenses only when they disperse cash Cash basis financial statements are not in conformity with GAAP. Pages 196-201 Adjust from accrual-basis to cash-basis and vice versa Advantages to accrual basis accounting: a) Todays economy is considerably more lubricated by credit than cash b) The accrual basis recognizes all aspects of the credit phenomenon c) Investors, creditors, and other decision makers seek timely information about an enterprises future cash flows Transaction Processing Understand the accounting cycle and its documents and procedures. Record business events in journal entry form. Chapter 3 Accounting Cycle Summarized page 191
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Review for Exam 1
Adjusting Entries
Be able to record the four types of adjusting journal entries and understand their role in the accounting cycle. Chapter 3 (Objective 5) Illustration 3-20 (Page 149) Pages 149-180 Journal Entries & Examples Be able to create Trial Balances: unadjusted, adjusted, and closing. Be able to use Trial Balances to create financial statements. Chapter 3 (Objective 4) Be able to record closing entries & understand their role in the accounting cycle Closing entries are used to reduce the balance of the income statement (revenue and expense) accounts to zero. to transfer net income or net loss to owners equity balance sheet (asset, liability and equity) accounts are not closed dividends are closed directly to retained earnings account
Trial Balances
Closing Entries
Page 187-188 Chapter 3 (Objective 7) Income Statement Be able to prepare in well structured form: Single-step vs. multi-step statements Subtotals of Gross profit, selling expenses, administrative expenses, operating expenses, operating income, income from continuing operations, net income Special items: Discontinued Operations (Page 239-241), Extraordinary Items (Page 242-247), Net of Tax presentation: Be able to allocate tax expense to discontinued operations, extraordinary items and income from continuing operations. Earnings per share Single-step income statement emphasizes total revenues and total
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Review for Exam 1
expenses Multi-step income statement (1) separates operating transactions from non-operating transactions (2) matches costs and expenses with related revenues (3) highlights certain intermediate components of income that analysts use. Intermediate components of the Income Statement: 1. 2. 3. 4. 5. 6. Operating section Non-operating section Income Tax Discontinued operations Extraordinary items Earnings per share
Reporting Irregular Items (when both Discontinued Operations and Extraordinary Items is present): Page 248 Earnings per share = Net Income Preferred Dividends / Weighted average number of shares outstanding Important business indicator Measures the dollars earned by each share of common stock Must be disclosed on the income statement Chapter 4 Single-Step Income Statement (Pages 229) Multi-Step Income Statement (Page 234) Unit 3 Homework and Practice (online) Be able to prepare in well-structured form: Understand where prior period adjustments are placed (Change in Accounting Principle and Correction of Error). Be able to use net of tax presentation of prior period adjustments. Chapter 3 Unit 2 Homework and Practice (online) Be able to prepare in well-structured form: Classified vs. unclassified balance sheets
Statement of Retained Earnings
Balance Sheet
Review for Exam 1
Chapter 5 Unit 3 Homework and Practice (online) Purpose and major categories on the statement Chapter 5 Purpose of statement of cash flows: To provide relevant information about the cash receipts and cash payments of an enterprise during a period. The statement provides answers to the following questions: 1) Where did the cash come from? 2) What was the cash used for? 3) What was the change in the cash balance? Three different activities: a) Operating cash inflows and outflows that enter into the determination of net income b) Investing cash inflows and outflows from non-current assets c) Financing cash inflows and outflows from non-current liabilities and equity The statements value is that it helps users evaluate liquidity, solvency and financial flexibility. Illustration 5-18 (Page 338 of Textbook Slides for Exam 1) The accounting institutions: FASB, SEC, AICPA and their components and impact on current GAAP FASB: Financial Accounting Standards Board AICPA: American Institute of Certified Public Accountants SEC: Securities and Exchange Commission GAAP: Generally Accepted Accounting Principles The accounting standard setting process Stakeholders in the accounting standard-setting process.
Statement of Cash Flows
Context of Accounting
Review for Exam 1
The role of GAAP in an economy Structure of the FASB Codification System FASB/IFRS state of convergence and some common differences. Chapter 1 The purpose of accounting, the qualitative characteristics of accounting information, the definition of elements of accounting, the principles / assumptions used in recognition and measurement. Chapter 2 Purpose of accounting: to provide financial information about the reporting entity that is useful to present and potential equity investors, lenders, and other creditors in making decisions about providing resources to the entity.
Conceptual Framework
Intermediate Accounting
1-1
Prepared by Coby Harmon University of California, Santa Barbara
Financial Accounting and Accounting Standards
Intermediate Accounting 14th Edition
Kieso, Weygandt, and Warfield

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Learning Objectives
1. 2. 3. 4. 5. 6. 7. 8. 9.
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Identify the major financial statements and other means of financial reporting. Explain how accounting assists in the efficient use of scarce resources. Identify the objective of financial reporting. Explain the need for accounting standards. Identify the major policy-setting bodies and their role in the standardsetting process. Explain the meaning of generally accepted accounting principles (GAAP) and the role of the Codification for GAAP. Describe the impact of user groups on the rule-making process. Describe some of the challenges facing financial reporting. Understand issues related to ethics and financial accounting.
Financial Accounting and Accounting Standards
Financial Statements and Financial Reporting

Accounting and capital allocation Objectives Need to develop standards
Parties Involved in Standard-Setting
Generally Accepted Accounting Principles

FASB Codification
Issues in Financial Reporting

Political environment Expectations gap Financial reporting challenges International accounting standards Ethics
Securities and Exchange Commission American Institute of CPAs Financial Accounting Standards Board Changing role of the AICPA
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Essential characteristics of accounting are:
(1) the identification, measurement, and communication of financial information about (2) economic entities to (3) interested parties.
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LO 1 Identify the major financial statements and other means of financial reporting.

Economic Entity
Financial Information Accounting? Identifies and Measures and Communicates
Financial Statements
Balance Sheet Income Statement Statement of Cash Flows Statement of Owners or Stockholders Equity Note Disclosures
Additional Information
Presidents letter Prospectuses Reports filed with governmental agencies News releases Forecasts Environmental impact statements Etc.
GAAP
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Review Question
What is the purpose of information presented in notes to the financial statements? a. To provide disclosure required by generally accepted accounting principles. To correct improper presentation in the financial statements. To provide recognition of amounts not included in the totals of the financial statements. To present managements responses to auditor comments.
b.
c.
d.
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Accounting and Capital Allocation
Resources are limited. Efficient use of resources often determines whether a business thrives.
Illustration 1-1 Capital Allocation Process
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LO 2 Explain how accounting assists in the efficient use of scare resources.
Accounting and Capital Allocation

Review Question
An effective process of capital allocation is critical to a healthy economy, which a. b. c. promotes productivity. encourages innovation. provides an efficient and liquid market for buying and selling securities. All of the above.
d.
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LO 2 Explain how accounting assists in the efficient use of scare resources.

Objectives of Financial Reporting
Provide financial information about the reporting entity that is useful to

present and potential equity investors, lenders, and other creditors
in making decisions in their capacity as capital providers.
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LO 3 Identify the objectives of financial reporting.
Objective of Financial Accounting

General-Purpose Financial Statements
Provide financial reporting information to a wide variety of users. Provide the most useful information possible at the least cost.
Equity Investors and Creditors

Investors are the primary user group.
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Objective of Financial Accounting

Entity Perspective
Companies viewed as separate and distinct from their owners.
Decision-Usefulness
Investors are interested in assessing the companys 1. ability to generate net cash inflows and 2. managements ability to protect and enhance the capital providers investments.
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Need to Develop Standards

Various users need financial information Financial Statements
Balance Sheet Income Statement Statement of Stockholders Equity Statement of Cash Flows Note Disclosure
The accounting profession has attempted to develop a set of standards that are generally accepted and universally practiced.
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Generally Accepted Accounting Principles (GAAP)
LO 4 Explain the need for accounting standards.
Parties Involved in Standard Setting

Three organizations:

Securities and Exchange Commission (SEC). American Institute of Certified Public Accountants (AICPA).
Financial Accounting Standards Board (FASB).
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LO 5 Identify the major policy-setting bodies and their role in the standard-setting process.

Securities and Exchange Commission (SEC)

Established by federal government. Accounting and reporting for public companies.
Securities Act of 1933

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Securities Act of 1934
http://www.sec.gov/
Encouraged private standard-setting body. SEC requires public companies to adhere to GAAP. SEC Oversight. Enforcement Authority.

American Institute of CPAs (AICPA)

National professional organization Established the following:

http://www.aicpa.org/
Committee on Accounting Procedures

Accounting Principles Board

1939 to 1959 Issued 51 Accounting Research Bulletins (ARBs) Problem-by-problem approach failed
1959 to 1973 Issued 31 Accounting Principle Board Opinions (APBOs) Wheat Committee recommendations adopted in 1973
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LO 5

Financial Accounting Standards Board (FASB)
Wheat Committees recommendations resulted in creation of FASB. Financial Accounting Foundation Financial Accounting Standards Board
Financial Accounting Standards Advisory Council
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Selects members of the FASB. Funds their activities. Exercises general oversight. Mission to establish and improve standards of financial accounting and reporting.
Consult on major policy issues.

LO 5
Financial Accounting Standards Board

Missions is to establish and improve standards of financial accounting and reporting. Differences between FASB and APB include:

Smaller Membership. Full-time, Remunerated Membership. Greater Autonomy. Increased Independence. Broader Representation.
http://www.fasb.org/
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Financial Accounting Standards Board Review

The first step taken in the establishment of a typical FASB statement is a. The board conducts research and analysis and a discussion memorandum is issued. A public hearing on the proposed standard is held. The board evaluates the research and public response and issues an exposure draft. Topics are identified and placed on the boards agenda.
b. c.
d.
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Illustration 1-3 The Due Process System of the FASB
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Types of Pronouncements

Standards, Interpretations, and Staff Positions. Financial Accounting Concepts. Emerging Issues Task Force Statements.
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CA1-14 (Accounting Pronouncements): Standard setting bodies have issued a number of authoritative pronouncements. A list is provided on the left, below, with a description of these pronouncements on the right.
(d) (f) (c) (e) (a) (b)
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LO 5

Changing Role of AICPA
The AICPA established the Accounting Standards Executive Committee (AcSEC):

Audit and Accounting Guides. Statements of Position (SOP). Practice Bulletins.
AICPA and AcSEC no longer issues authoritative accounting guidance for public companies. PCAOB oversees the development of auditing standards.
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Principles that have substantial authoritative support. Major sources of GAAP:

FASB Standards, Interpretations, and Staff Positions. APB Opinions. AICPA Accounting Research Bulletins.
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LO 6 Explain the meaning of generally accepted accounting principles (GAAP) and the role of the Codification for GAAP.

Illustration 1-4 GAAP Documents
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Generally Accepted Accounting Principles Review

Which of the following accounting pronouncements is the most authoritative? a. b. c. d. FASB Statement of Financial Accounting Concepts. FASB Technical Bulletins. AICPA Accounting Principles Board Opinion. AICPA Statement of Position.
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FASB Codification
Goal in developing the Codification is to provide in one place all the authoritative literature related to a particular topic. Creates one level of GAAP, which is considered authoritative. All other accounting literature is considered non-authoritative.
FASB has developed the Financial Accounting Standards Board Codification Research System (CRS). CRS is an online real-time database that provides easy access to the Codification.
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LO 6

Illustration 1-5 FASB Codification Framework
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LO 6

GAAP in a Political Environment
GAAP is as much a product of political action as they are of careful logic or empirical findings.
Illustration 1-6 User Groups that Influence the Formulation of Accounting Standards
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LO 7 Describe the impact of user groups on the rule-making process.

Expectation GAAP
What the public thinks accountants should do vs. what accountants think they can do.

Difficult to close in light of accounting scandals. Sarbanes-Oxley Act (2002). Public Company Accounting Oversight Board (PCAOB).
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LO 7 Describe the impact of user groups on the rule-making process.

Financial Reporting Challenges

Non-financial measurements. Forward-looking information. Soft assets. Timeliness
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LO 8 Describe some of the challenges facing financial reporting.

International Accounting Standards
Two sets of standards accepted for international use:

U.S. GAAP, issued by the FASB. International Financial Reporting Standards (IFRS), issued by the IASB.
FASB and IASB recognize that global markets will best be served if only one set of GAAP is used.
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CA1-9 (GAAP Terminology): With accounting and finance, it often helps to be fluent in abbreviations and acronyms. Instructions: Presented below is a list of common accounting acronyms. Identify the term for which each acronym stands, and provide a brief definition of each term. (a) AICPA (b) CAP (c) ARB (d) APB
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(e) FAF (f) FASAC (g) SOP (h) GAAP
(i) CPA (j) FASB (k) SEC (l) IASB

Ethics in the Environment of Financial Accounting
In accounting, we frequently encounter ethical dilemmas.

GAAP does not always provide an answer. Doing the right thing is not always easy or obvious.
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LO 9 Understand issues related to ethics and financial accounting.
RELEVANT FACTS
International standards are referred to as International Financial Reporting Standards (IFRS), developed by the International Accounting Standards Board (IASB). Recent events in the global capital markets have underscored the importance of financial disclosure and transparency not only in the United States but in markets around the world. As a result, many are examining which accounting and financial disclosure rules should be followed. U.S standards, referred to as generally accepted accounting principles (GAAP), are developed by the Financial Accounting Standards Board (FASB). The fact that there are differences between what is in this textbook (which is based on U.S. standards) and IFRS should not be surprising because the FASB and IASB have responded to different user needs.
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RELEVANT FACTS
The internal control standards applicable to Sarbanes-Oxley (SOX) apply only to large public companies listed on U.S. exchanges. There is a continuing debate as to whether non-U.S. companies should have to comply with this extra layer of regulation. Debate about international companies (non-U.S.) adopting SOX-type standards centers on whether the benefits exceed the costs. The concern is that the higher costs of SOX compliance are making the U.S. securities markets less competitive. The textbook mentions a number of ethics violations, such as WorldCom, AIG, and Lehman Brothers. These problems have also occurred internationally, for example, at Satyam Computer Services (India), Parmalat (Italy), and Royal Ahold (the Netherlands).
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RELEVANT FACTS
IFRS tends to be simpler in its accounting and disclosure requirements; some people say more principles-based. GAAP is more detailed; some people say more rules-based. This difference in approach has resulted in a debate about the merits of principlesbased versus rules-based standards. The SEC allows foreign companies that trade shares in U.S. markets to file their IFRS financial statements without reconciliation to GAAP.
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ABOUT THE NUMBERS
Illustration IFRS1-1 Global Companies
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International Standard-Setting Organizations:

International Accounting Standards Board (IASB)
Issues International Financial Reporting Standards (IFRS). Standards used on most foreign exchanges. Standards used by foreign companies listing on U.S. securities exchanges. IFRS used in over 115 countries.
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International Organization of Securities Commissions (IOSCO)

Does not set accounting standards. Dedicated to ensuring that global markets can operate in an efficient and effective basis.
http://www.iosco.org/
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International Accounting Standards Board (IASB)

Composed of four organizations
International Accounting Standards Committee Foundation (IASCF). International Accounting Standards Board (IASB). Standards Advisory Council. International Financial Reporting Interpretations Committee (IFRIC).
http://www.iasb.org
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Illustration IFRS1-2 International Standard-Setting Structure
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Review Question
IFRS stands for: a. International Federation of Reporting Services. b. Independent Financial Reporting Standards. c. International Financial Reporting Standards. d. Integrated Financial Reporting Services.
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Review Question
The major key players on the international side are the: a. IASB and FASB. b. SEC and FASB. c. IOSCO and the SEC. d. IASB and IOSCO.
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Review Question
Which body from the U.S. side is similar to the IASB? a. SEC. b. FASB. c. FASC. d. FAF.
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International Financial Reporting Standards. Framework for financial reporting. International financial reporting interpretations.
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Hierarchy of IFRS
Companies first look to: 1. International Financial Reporting Standards; 2. International Accounting Standards; and 3. Interpretations originated by the International Financial Reporting Interpretations Committee (IFRIC) or the former Standing Interpretations Committee (SIC).
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Review Question
IFRS is comprised of: a. International Financial Reporting Standards and FASB financial reporting standards. b. International Financial Reporting Standards, International Accounting Standards, and international accounting interpretations. c. International Accounting Standards and international accounting interpretations. d. FASB financial reporting standards and International Accounting Standards.
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International Convergence
The SEC appears committed to move to IFRS, assuming that certain conditions are met.
Illustration IFRS1-3 SEC Roadmap
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International Convergence
The SEC will decide, sometime in 2011, whether to mandate the use of IFRS. It is likely that not all companies would be required immediately to change to IFRS, but there would be a transition period in which this would be accomplished.
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Copyright
Copyright 2012 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.
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2-1
Conceptual Framework for Financial Accounting

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Learning Objectives
1. 2. 3. 4. 5. 6. 7. 8. Describe the usefulness of a conceptual framework. Describe the FASBs efforts to construct a conceptual framework. Understand the objectives of financial reporting. Identify the qualitative characteristics of accounting information. Define the basic elements of financial statements. Describe the basic assumptions of accounting. Explain the application of the basic principles of accounting. Describe the impact that constraints have on reporting accounting information.
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Conceptual Framework For Financial Accounting
First Level: Basic Objectives
Second Level: Fundamental Concepts

Qualitative characteristics Basic elements
Third Level: Recognition and Measurement

Basic assumptions Basic principles Constraints Summary of the structure
Need Development Overview
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The Need for a Conceptual Framework

To develop a coherent set of standards and rules. To solve new and emerging practical problems.
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LO 1 Describe the usefulness of a conceptual framework.
Review Question (true or false):
A conceptual framework underlying financial accounting is important because it can lead to consistent standards and it prescribes the nature, function, and limits of financial accounting and financial statements.
True
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Review Question (true or false):
A conceptual framework underlying financial accounting is necessary because future accounting practice problems can be solved by reference to the conceptual framework and a formal standard-setting body will not be necessary.
False
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Development of Conceptual Framework

The FASB has issued seven Statements of Financial Accounting Concepts (SFAC) for business enterprises.
SFAC No.1 - Objectives of Financial Reporting. SFAC No.2 - Qualitative Characteristics of Accounting Information. SFAC No.3 - Elements of Financial Statements. SFAC No.5 - Recognition and Measurement in Financial Statements. SFAC No.6 - Elements of Financial Statements (replaces SFAC No. 3). SFAC No.7 - Using Cash Flow Information and Present Value in Accounting Measurements. SFAC No.8 - The Objective of General Purpose Financial Reporting and Qualitative Characteristics of Useful Financial Information (replaces SFAC No. 1 and No. 2)
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LO 2
Overview of the Conceptual Framework

First Level = Basic Objectives Second Level = Qualitative Characteristics and Elements
Third Level = Recognition, Measurement, and Disclosure Concepts.
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LO 2 Describe the FASBs efforts to construct a conceptual framework.
Illustration 2-7 Conceptual Framework for Financial Reporting
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LO 2
Review
What are the Statements of Financial Accounting Concepts intended to establish? a. Generally accepted accounting principles in financial reporting by business enterprises. The meaning of Present fairly in accordance with generally accepted accounting principles. The objectives and concepts for use in developing standards of financial accounting and reporting. The hierarchy of sources of generally accepted accounting principles.
LO 2 Describe the FASBs efforts to construct a conceptual framework.
b.
c.
d.
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Objective of general-purpose financial reporting is:
To provide financial information about the reporting entity that is useful to present and potential equity investors, lenders, and other creditors in making decisions about providing resources to the entity.
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LO 3 Understand the objectives of financial reporting.

Review
According to the FASB conceptual framework, the objectives of financial reporting for business enterprises are based on? a. Generally accepted accounting principles b. Reporting on managements stewardship. c. The need for conservatism. d. The needs of the users of the information.
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LO 3 Understand the objectives of financial reporting.
Second Level: Fundamental Concepts

Qualitative Characteristics
The FASB identified the Qualitative Characteristics of accounting information that distinguish better (more useful) information from inferior (less useful) information for decision-making purposes.
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LO 4 Identify the qualitative characteristics of accounting information.
Second Level: Qualitative Characteristics
Illustration 2-2 Hierarchy of Accounting Qualities
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Relevance
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LO 4

Fundamental QualityRelevance
To be relevant, accounting information must be capable of making a difference in a decision.
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Financial information has predictive value if it has value as an input to predictive processes used by investors to form their own expectations about the future.
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Relevant information also helps users confirm or correct prior expectations.
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Information is material if omitting it or misstating it could influence decisions that users make on the basis of the reported financial information.
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Faithful Representation
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LO 4

Fundamental QualityFaithful Representation
Faithful representation means that the numbers and descriptions match what really existed or happened.
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Completeness means that all the information that is necessary for faithful representation is provided.
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Neutrality means that a company cannot select information to favor one set of interested parties over another.
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An information item that is free from error will be a more accurate (faithful) representation of a financial item.
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Enhancing Qualities
Information that is measured and reported in a similar manner for different companies is considered comparable.
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Enhancing Qualities
Verifiability occurs when independent measurers, using the same methods, obtain similar results.
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Enhancing Qualities
Timeliness means having information available to decisionmakers before it loses its capacity to influence decisions.
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Enhancing Qualities
Understandability is the quality of information that lets reasonably informed users see its significance.
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Basic Elements
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LO 5
Second Level: Basic Elements

Concepts Statement No. 6 defines ten interrelated elements that relate to measuring the performance and financial status of a business enterprise.
Moment in Time

Period of Time

Assets Liabilities Equity
Investment by owners Distribution to owners Comprehensive income Revenue Expenses Gains Losses
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LO 5 Define the basic elements of financial statements.

Exercise 2-5: Identify the element or elements associated with items below. Elements
(a) Arises from peripheral or incidental transactions. (b) Obligation to transfer resources arising from a past transaction. (c) Increases ownership interest. (d) Declares and pays cash dividends to owners. (e) Increases in net assets in a period from nonowner sources. Assets
(b) (c) (d) (e) (c)
Liabilities Equity Investment by owners Distribution to owners Comprehensive income Revenue Expenses
(a) (a)
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Gains Losses
LO 5

Exercise 2-5: Identify the element or elements associated with items below. Elements (f) Assets (f) Items characterized by future
economic benefit. (g) Equals increase in net assets during the year, after adding distributions to owners and subtracting investments by owners. (h) Arises from income statement activities that constitute the entitys ongoing major or central operations.
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Liabilities Equity Investment by owners Distribution to owners
(g) (h) (h)
Comprehensive income Revenue Expenses Gains Losses

LO 5

Exercise 2-5: Identify the element or elements associated with items below. Elements
(i) Residual interest in the net assets of the enterprise. (j) Increases assets through sale of product. (k) Decreases assets by purchasing the companys own stock. (l) Changes in equity during the period, except those from investments by owners and distributions to owners.
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Assets Liabilities
(i) (k) (l) (j)
Equity Investment by owners Distribution to owners Comprehensive income Revenue Expenses Gains Losses
LO 5
Second Level: Basic Elements Review:

According to the FASB conceptual framework, an entitys revenue may result from a. A decrease in an asset from primary operations. b. An increase in an asset from incidental transactions. c. An increase in a liability from incidental transactions. d. A decrease in a liability from primary operations.
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LO 5 Define the basic elements of financial statements.
Third Level: Recognition and Measurement

The FASB sets forth most of these concepts in its Statement of Financial Accounting Concepts No. 5, Recognition and Measurement in Financial Statements of Business Enterprises.
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LO 5
Third Level: Basic Assumptions

Economic Entity company keeps its activity separate from
its owners and other businesses.
Going Concern - company to last long enough to fulfill

objectives and commitments.
Monetary Unit - money is the common denominator. Periodicity - company can divide its economic activities into
time periods.
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LO 6 Describe the basic assumptions of accounting.
Third Level: Assumptions

Brief Exercise 2-7: Identify which basic assumption of accounting is best described in each item below.
(a) The economic activities of KC Corporation are divided into 12-month periods for the purpose of issuing annual reports. (b) Solectron Corporation, Inc. does not adjust amounts in its financial statements for the effects of inflation. (c) Walgreen Co. reports current and noncurrent classifications in its balance sheet. (d) The economic activities of General Electric and its subsidiaries are merged for accounting and reporting purposes.
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Periodicity Monetary Unit Going Concern Economic Entity
LO 6 Describe the basic assumptions of accounting.
Third Level: Basic Principles

Measurement Principle The most commonly used
measurements are based on historical cost and fair value.
Issues:
Historical cost provides a reliable benchmark for measuring historical trends. Fair value information may be more useful. Recently the FASB has taken the step of giving companies the option to use fair value as the basis for measurement of financial assets and financial liabilities. Reporting of fair value information is increasing.
LO 7 Explain the application of the basic principles of accounting.
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Revenue Recognition - generally occurs (1) when realized
or realizable and (2) when earned. Exceptions:
Illustration 2-5 Timing of Revenue Recognition
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Expense Recognition - Let the expense follow the
revenues.
Illustration 2-6 Expense Recognition
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Full Disclosure providing information that is of sufficient
importance to influence the judgment and decisions of an informed user. Provided through:

Financial Statements Notes to the Financial Statements Supplementary information
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Brief Exercise 2-8: Identify which basic principle of accounting is best described in each item below.
(a) KC Corporation reports revenue in its income statement when it is earned instead of when the cash is collected. (b) Yahoo, Inc. recognizes depreciation expense for a machine over the 2-year period during which that machine helps the company earn revenue. (c) Oracle Corporation reports information about pending lawsuits in the notes to its financial statements. (d) Eastman Kodak Company reports land on its balance sheet at the amount paid to acquire it, even though the estimated fair market value is greater.
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Revenue Recognition Expense Recognition Full Disclosure Measurement
Third Level: Constraints

Cost Constraint cost of providing information must be
weighed against the benefits that can be derived from using it.
Industry Practice - the peculiar nature of some industries

and business concerns sometimes requires departure from basic accounting theory.
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LO 8 Describe the impact that constraints have on reporting accounting information.
Third Level: Constraints

Brief Exercise 2-10: What accounting constraints are illustrated by the items below?
(a) KC, Inc. reports agricultural crops on its balance sheet at market value. (b) Rafael Corporation discloses fair value information on its loans because it already gathers this information internally. (c) Willis Company does not disclose any information in the notes to the financial statements unless the value of the information to users exceeds the expense of gathering it. (d) A broker-dealer records all assets and liabilities at fair value.
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Industry Practice Cost Constraint Cost Constraint
Industry Practice
LO 8
Summary of the Structure
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RELEVANT FACTS
In 2010, the IASB and FASB completed the first phase of a jointly created conceptual framework. In this first phase, they agreed on the objective of financial reporting and a common set of desired qualitative characteristics. The existing conceptual frameworks underlying GAAP and IFRS are very similar. The converged framework should be a single document, unlike the two conceptual frameworks that presently exist; it is unlikely that the basic structure related to the concepts will change.
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RELEVANT FACTS
Both the IASB and FASB have similar measurement principles, based on historical cost and fair value. Although both GAAP and IFRS are increasing the use of fair value to report assets, at this point IFRS has adopted it more broadly. GAAP has a concept statement to guide estimation of fair values when market-related data is not available (Statement of Financial Accounting Concepts No. 7, Using Cash Flow Information and Present Value in Accounting). The IASB is considering a proposal to provide expanded guidance on estimating fair values. The monetary unit assumption is part of each framework. However, the unit of measure will vary depending on the currency used in the country in which the company is incorporated.
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RELEVANT FACTS
The economic entity assumption is also part of each framework although some cultural differences result in differences in its application. For example, in Japan many companies have formed alliances that are so strong that they act similar to related corporate divisions although they are not actually part of the same company.
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ABOUT THE NUMBERS International Standard-Setting Organizations:

While the conceptual framework that underlies IFRS is very similar to that used to develop GAAP, the elements identified and their definitions under IFRS are different. The IASB elements and their definitions are as follows. Assets. A resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity. Liabilities. A present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits. Liabilities may be legally enforceable via a contract or law, but need not be, i.e., they can arise due to normal business practice or customs.
2-50
ABOUT THE NUMBERS International Standard-Setting Organizations:

While the conceptual framework that underlies IFRS is very similar to that used to develop GAAP, the elements identified and their definitions under IFRS are different. The IASB elements and their definitions are as follows. Equity. A residual interest in the assets of the entity after deducting all its liabilities. Income. Increases in economic benefits that result in increases in equity (other than those related to contributions from shareholders). Income includes both revenues (resulting from ordinary activities) and gains. Expenses. Decreases in economic benefits that result in decreases in equity (other than those related to distributions to shareholders). Expenses includes losses that are not the result of ordinary activities.
2-51
IFRS SELF-TEST QUESTION

Which of the following statements about the IASB and FASB conceptual frameworks is not correct? a. The IASB conceptual framework does not identify the element comprehensive income. b. The existing IASB and FASB conceptual frameworks are organized in similar ways. c. The FASB and IASB agree that the objective of financial reporting is to provide useful information to investors and creditors. d. IFRS does not allow use of fair value as a measurement basis.
2-52

Which of the following statements is false? a. The monetary unit assumption is used under IFRS. b. Under IFRS, companies may use fair value for property, plant, and equipment. c. The FASB and IASB are working on a joint conceptual framework project. d. Under IFRS, there are the same number of financial statement elements as in GAAP.
2-53

The issues that the FASB and IASB must address in developing a common conceptual framework include all of the following except: a. Should the characteristic of relevance be traded-off in favor of information that is verifiable? b. Should a single measurement method be used? c. Should the common framework lead to standards that are principles-based or rules-based? d. Should the role of financial reporting focus on stewardship as well as providing information to assist users in decisionmaking?
2-54
Copyright
2-55
3-1
The Accounting Information System

3-2
Learning Objectives
1. 2. 3. 4. 5. 6. 7. Understand basic accounting terminology. Explain double-entry rules. Identify steps in the accounting cycle. Record transactions in journals, post to ledger accounts, and prepare a trial balance. Explain the reasons for preparing adjusting entries. Prepare financial statement from the adjusted trial balance. Prepare closing entries.
3-3
The Accounting Information System
Accounting Information System

Basic terminology Debits and credits Accounting equation Financial statements and ownership structure
The Accounting Cycle

Identifying and recording Journalizing Posting Trial balance Adjusting entries Adjusted trial balance Preparing financial statements Closing Post-closing trial balance Reversing entries
Financial Statements for Merchandisers

Income statement Statement of retained earnings Balance sheet Closing entries
3-4

Accounting Information System (AIS)

Collects and processes transaction data. Disseminates the information to interested parties.
3-5

Helps management answer such questions as:

How much and what kind of debt is outstanding? Were sales higher this period than last? What assets do we have? What were our cash inflows and outflows? Did we make a profit last period? Are any of our product lines or divisions operating at a loss? Can we safely increase our dividends to stockholders? Is our rate of return on net assets increasing?
3-6

Basic Terminology

Event Transaction Account Real Account Nominal Account Ledger
Journal Posting Trial Balance Adjusting Entries Financial Statements Closing Entries
3-7
LO 1 Understand basic accounting terminology.

Debits and Credits
An Account shows the effect of transactions on a given asset, liability, equity, revenue, or expense account.
Double-entry accounting system (two-sided effect). Recording done by debiting at least one account and crediting another.
3-8
DEBITS must equal CREDITS.

LO 2 Explain double-entry rules.
Debits and Credits

Account
An arrangement that shows the effect of transactions on an account. Debit = Left Credit = Right
Account Name
Debit / Dr. Credit / Cr.
An Account can be illustrated in a T-Account form.
3-9
Debits and Credits

If Debit entries are greater than Credit entries, the account will have a debit balance.
Account Name
Transaction #1 Transaction #3
$10,000 8,000
$3,000
Transaction #2
Balance
$15,000
3-10
Debits and Credits

If Credit entries are greater than Debit entries, the account will have a credit balance.
Account Name
Transaction #1
$10,000
$3,000 8,000
Transaction #2 Transaction #3
Balance
$1,000
3-11
Debits and Credits Summary

Liabilities
Normal Balance Debit

Assets
Normal Balance Credit

Equity
Debit / Dr.
Chapter 3-24
Debit / Dr.
Credit / Cr.
Normal Balance
Credit / Cr.
Normal Balance Normal Balance

Chapter 3-23
Expense
Chapter 3-25
Revenue
Normal Balance
Normal Balance
Chapter 3-27
Chapter 3-26
3-12
Debits and Credits Summary

Balance Sheet Income Statement
Asset = Liability + Equity Revenue - Expense =
Debit
Credit
3-13
The Accounting Equation

Relationship among the assets, liabilities and stockholders equity of a business:
Illustration 3-3
The equation must be in balance after every transaction. For every Debit there must be a Credit.
3-14
Double-Entry System Illustration

1. Owners invest $40,000 in exchange for common stock. Assets = Liabilities +
Stockholders Equity
+ 40,000
+ 40,000
3-15

2. Disburse $600 cash for secretarial wages.
Assets
Liabilities
Stockholders Equity
- 600
- 600
(expense)
3-16

3. Purchase office equipment priced at $5,200, giving a 10 percent promissory note in exchange. Assets = Liabilities +
Stockholders Equity
+ 5,200
+ 5,200
3-17

4. Received $4,000 cash for services rendered.
Assets
Liabilities
Stockholders Equity
+ 4,000
+ 4,000
(revenue)
3-18

5. Pay off a short-term liability of $7,000.
Assets
Liabilities
Stockholders Equity
- 7,000
- 7,000
3-19

6. Declared a cash dividend of $5,000.
Assets
Liabilities
Stockholders Equity
+ 5,000
- 5,000
3-20

7. Convert a long-term liability of $80,000 into common stock. Assets = Liabilities +
Stockholders Equity
- 80,000
+ 80,000
3-21

8. Pay cash of $16,000 for a delivery van.
Assets
Liabilities
Stockholders Equity
- 16,000 + 16,000
Note that the accounting equation equality is maintained after recording each transaction.
3-22
Financial Statements and Ownership Structure

Ownership structure dictates the types of accounts that are part of the equity section.
Proprietorship or Partnership

Corporation
Capital Account Drawing Account
Common Stock Additional Paid-in Capital Dividends Declared Retained Earnings
3-23
Financial Statements and Ownership Structure

Balance Sheet Stockholders Equity Common Stock
(Investment by stockholders)
Illustration 3-4
Retained Earnings
(Net income retained in business)
Net income or Net loss Dividends

(Revenues less expenses)
Income Statement Statement of Retained Earnings

3-24
The Accounting Cycle

Illustration 3-6
Transactions 9. Reversing entries 1. Journalization
8. Post-closing trail balance
2. Posting
7. Closing entries
Work Sheet
3. Trial balance
6. Financial Statements
4. Adjustments
5. Adjusted trial balance
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LO 3 Identify steps in the accounting cycle.
Identify and Recording Transactions

What to Record? FASB states, transactions and other events and circumstances that affect a business enterprise. Types of Events:

External between a business and its environment. Internal event occurring entirely within a business.
3-26
LO 3 Identify steps in the accounting cycle.
1. Journalizing
General Journal a chronological record of transactions. Journal Entries are recorded in the journal.
September 1: Stockholders invested $15,000 cash in the corporation in exchange for shares of stock.
Illustration 3-7
3-27
LO 4 Record transactions in journals, post to ledger accounts, and prepare a trial balance.
2. Posting
Posting the process of transferring amounts from the journal to the ledger accounts.
Illustration 3-7
Illustration 3-8
3-28
2. Posting
Posting Transferring amounts from journal to ledger.
Illustration 3-8
3-29
LO 4
2. Posting
Expanded Example
The purpose of transaction analysis is (1) to identify the type of account involved, and (2) to determine whether a debit or a credit is required.
Keep in mind that every journal entry affects one or more of the following items: assets, liabilities, stockholders equity, revenues, or expense.
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2. Posting
1. October 1: Stockholders invest $100,000 cash in an advertising venture to be known as Pioneer Advertising Agency Inc. Oct. 1 Cash Common stock
Cash Debit 100,000 Credit
100,000 100,000
Common Stock Debit Credit 100,000
3-31
2. Posting
2. October 1: Pioneer Advertising purchases office equipment costing $50,000 by signing a 3-month, 12%, $50,000 note payable. Oct. 1 Equipment Notes payable
Equipment Debit 50,000 Credit Notes Payable Debit Credit 50,000
50,000 50,000
3-32
2. Posting
3. October 2: Pioneer Advertising receives a $12,000 cash advance from KC, a client, for advertising services that are expected to be completed by December 31. Oct. 2 Cash Unearned service revenue
Cash Debit 100,000 12,000 Credit
12,000 12,000
Unearned Service Revenue Debit Credit 12,000
3-33
2. Posting
4. October 3: Pioneer Advertising pays $9,000 office rent, in cash, for October. Oct. 3 Rent expense Cash 9,000 9,000
Cash Debit 100,000 12,000 Credit 9,000
Rent Expense Debit 9,000 Credit
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2. Posting
5. October 4: Pioneer Advertising pays $6,000 for a one-year insurance policy that will expire next year on September 30. Oct. 4 Prepaid insurance Cash 6,000 6,000
Cash Debit 100,000 12,000 Credit 9,000 6,000
Prepaid Insurance Debit 6,000 Credit
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2. Posting
6. October 5: Pioneer Advertising purchases, for $25,000 on account, an estimated 3-month supply of advertising materials from Aero Supply. Oct. 5 Supplies Accounts payable
Supplies Debit 25,000 Credit
25,000 25,000
Accounts Payable Debit Credit 25,000
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2. Posting
7. October 9: Pioneer Advertising signs a contract with a local newspaper for advertising inserts (flyers) to be distributed starting the last Sunday in November. Pioneer will start work on the content of the flyers in November. Payment of $7,000 is due following delivery of the Sunday papers containing the flyers.
LO 4
3-37
Record transactions in journals, post to ledger accounts, and prepare a trial balance.
2. Posting
8. October 20: Pioneer Advertisings board of directors declares and pays a $5,000 cash dividend to stockholders. Oct. 20 Dividends Cash 5,000 5,000
Cash Debit 100,000 12,000 Credit 9,000 6,000 5,000
Dividends Debit 5,000 Credit
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2. Posting
9. October 26: Employees are paid every four weeks. The total payroll is $2,000 per day. The pay period ended on Friday, October 26, with salaries of $40,000 being paid. Oct. 26 Salaries expense Cash
Cash Debit 100,000 12,000 Credit 9,000 6,000 5,000 40,000
3-39
40,000 40,000
Salaries Expense Debit 40,000 Credit
2. Posting
10. October 31: Pioneer Advertising receives $28,000 in cash and bills Copa Company $72,000 for advertising services of $100,000 provided in October. Oct. 31 Cash Accounts receivable Service revenue
Cash Debit 100,000 12,000 28,000 80,000
3-40
28,000 72,000 100,000

Service Revenue Debit Credit 100,000
Accounts Receivable Credit 9,000 6,000 5,000 40,000 Debit 72,000 Credit
3. Trial Balance
Illustration 3-19
Trial Balance A list of each account and its balance; used to prove equality of debit and credit balances.
3-41
LO 4
4. Adjusting Entries
Makes it possible to:
Report on the statement of financial position the appropriate assets, liabilities, and equity at the statement date. Report on the income statement the proper revenues and expenses for the period.
Revenues are recorded in the period in which they are earned. Expenses are recognized in the period in which they are incurred.
3-42
LO 5 Explain the reasons for preparing adjusting entries.
Types of Adjusting Entries

Illustration 3-20
Prepayments
1. Prepaid Expenses. Expenses paid in cash and recorded as assets before they are used or consumed. 2. Unearned Revenues. Revenues received in cash and recorded as liabilities before they are earned.
Accruals
3. Accrued Revenues. Revenues earned but not yet received in cash or recorded. 4. Accrued Expenses. Expenses incurred but not yet paid in cash or recorded.
3-43
Adjusting Entries for Deferrals

Deferrals are either
prepaid expenses or unearned revenues.
Illustration 3-21
3-44
Adjusting Entries for Prepaid Expenses

Payment of cash that is recorded as an asset because service or benefit will be received in the future. Cash Payment
BEFORE
Expense Recorded
Prepayments often occur in regard to:

insurance supplies advertising
rent buildings and equipment
3-45

Supplies. Pioneer purchased advertising supplies costing $25,000 on October 5. Prepare the journal entry to record the purchase of the supplies. Oct. 5 Supplies Cash
Supplies Debit 25,000 Credit Debit Cash Credit 25,000
25,000 25,000
3-46

Supplies. An inventory count at the close of business on October 31 reveals that $10,000 of the advertising supplies are still on hand. Oct. 31 Supplies expense Supplies
Supplies Debit 25,000 10,000
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15,000 15,000
Supplies Expense Debit 15,000 Credit
Credit 15,000

Statement Presentation:
Supplies identifies that portion of the assets cost that will provide future economic benefit.
Illustration 3-35
3-48
Illustration 3-35

Supplies expense identifies that portion of the assets cost that expired in October.
Illustration 3-35
3-49

Insurance. On Oct. 4th, Pioneer paid $6,000 for a one-year fire insurance policy, beginning October 1. Show the entry to record the purchase of the insurance. Oct. 4 Prepaid insurance Cash
Prepaid Insurance Debit 6,000 Credit Debit Cash Credit 6,000
6,000 6,000
3-50

Insurance. An analysis of the policy reveals that $500 ($6,000 / 12) of insurance expires each month. Thus, Pioneer makes the following adjusting entry. Oct. 31 Insurance expense Prepaid insurance
Prepaid Insurance Debit 6,000 5,500
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500 500
Insurance Expense Debit 500 Credit
Credit 500

Prepaid insurance identifies that portion of the assets cost that will provide future economic benefit.
Illustration 3-35
3-52
Illustration 3-35

Insurance expense identifies that portion of the assets cost that expired in October.
Illustration 3-35
3-53

Depreciation. Pioneer Advertising estimates depreciation on its office equipment to be $400 per month. Accordingly, Pioneer recognizes depreciation for October by the following adjusting entry. Oct. 31 Depreciation expense Accumulated depreciation
Depreciation Expense Debit 400 Credit
400 400
Accumulated Depreciation Debit Credit 400
3-54

Accumulated Depreciationis a contra asset account.
Illustration 3-35
3-55
Illustration 3-35

Depreciation expense identifies that portion of the assets cost that expired in October.
Illustration 3-35
3-56
Adjusting Entries for Unearned Revenues

Receipt of cash that is recorded as a liability because the revenue has not been earned. Cash Receipt
BEFORE
Revenue Recorded
Unearned revenues often occur in regard to:

rent airline tickets school tuition
magazine subscriptions customer deposits
3-57

Unearned Revenue. Pioneer Advertising received $12,000 on October 2 from KC for advertising services expected to be completed by December 31. Show the journal entry to record the receipt on Oct. 2nd. Oct. 2 Cash 12,000 12,000 Unearned advertising revenue
Cash Debit 12,000 Credit
Unearned Rent Revenue Debit Credit 12,000
3-58

Unearned Revenues. Analysis reveals that Pioneer earned $4,000 of the advertising services in October. Thus, Pioneer makes the following adjusting entry. Oct. 31 Unearned service revenue Service revenue
Service Revenue Debit Credit 100,000 4,000
4,000 4,000
Unearned Service Revenue Debit 4,000 Credit 12,000 8,000
3-59

Unearned service revenue identifies that portion of the liability that has not been earned.
Illustration 3-35
3-60
Illustration 3-35

Service Revenue includes the portion of unearned service revenue earned in October.
Illustration 3-35
3-61
Adjusting Entries for Accruals

Accruals are either
accrued revenues or accrued expenses.
Illustration 3-27
3-62
Adjusting Entries for Accrued Revenues

Revenues earned but not yet received in cash or recorded. Adjusting entry results in: Revenue Recorded
BEFORE
Cash Receipt
Accrued revenues often occur in regard to:

rent interest services performed

3-63

Accrued Revenues. In October Pioneer earned $2,000 for advertising services that it did not bill to clients before October 31. Thus, Pioneer makes the following adjusting entry. Oct. 31 Accounts receivable Service revenue
Accounts Receivable Debit 72,000 2,000 74,000
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2,000 2,000
Service Revenue Debit Credit 100,000 4,000 2,000 106,000
LO 5
Credit

Illustration 3-35
Illustration 3-35
3-65
LO 5
Adjusting Entries for Accrued Expenses

Expenses incurred but not yet paid in cash or recorded. Adjusting entry results in: Expense Recorded
BEFORE
Cash Payment, if any*
Accrued expenses often occur in regard to:

rent interest taxes
salaries bad debts*
3-66

Accrued Interest. Pioneer signed a three-month, 12%, note payable in the amount of $50,000 on October 1. The note requires interest at an annual rate of 12 percent. Three factors determine the amount of the interest accumulation:
Illustration 3-29
3-67

Accrued Interest. Pioneer signed a three-month, 12%, note payable in the amount of $50,000 on October 1. Prepare the adjusting entry on Oct. 31 to record the accrual of interest. Oct. 31 Interest expense Interest payable
Interest Expense Debit 500 Credit Interest Payable Debit Credit 500
500 500
3-68

Illustration 3-35
Illustration 3-35
3-69
LO 5
Accrued Salaries. At October 31, the salaries for these days represent an accrued expense and a related liability to Pioneer. The employees receive total salaries of $10,000 for a five-day work week, or $2,000 per day.
3-70

Accrued Salaries. Employees receive total salaries of $10,000 for a five-day work week, or $2,000 per day. Prepare the adjusting entry on Oct. 31 to record accrual for salaries. Oct. 31 Salaries expense Salaries payable
Salaries Expense Debit 40,000 6,000 46,000
3-71
6,000 6,000
Salaries Payable Debit Credit 6,000
Credit

Accrued Salaries. On November 23, Pioneer will again pay total salaries of $40,000. Prepare the entry to record the payment of salaries on November 23. Nov. 23 Salaries payable Salaries expense Cash
Salaries Expense Debit 34,000 Credit
6,000 34,000 40,000

Salaries Payable Debit 6,000 Credit 6,000
3-72

Illustration 3-35
Illustration 3-35
3-73
LO 5

Bad Debts. Assume Pioneer reasonably estimates a bad debt expense for the month of $1,600. It makes the adjusting entry for bad debts as follows.
Illustration 3-32
3-74

Illustration 3-35
Illustration 3-35
3-75
LO 5
5. Adjusted Trial Balance

Shows the balance of all accounts, after adjusting entries, at the end of the accounting period.
3-76
Illustration 3-33
6. Preparing Financial Statements

Financial Statements are prepared directly from the Adjusted Trial Balance.
Income Statement
Retained Earnings Statement
Balance Sheet
3-77
LO 6 Prepare financial statement from the adjusted trial balance.
Illustration 3-34 3-78
LO 6
LO 6
7. Closing Entries
To reduce the balance of the income statement (revenue and expense) accounts to zero. To transfer net income or net loss to owners equity. Balance sheet (asset, liability, and equity) accounts are not closed. Dividends are closed directly to the Retained Earnings account.
3-80
LO 7 Prepare closing entries.
7. Closing Entries
Illustration 3-33
Closing Journal Entries:

Retained earnings Dividends Service revenue Supplies expense Rent expense Insurance expense Interest expense Depreciation expense Bad debt expense Retained earnings 5,000 5,000 106,000 15,000 9,000 500 500 400 1,600 33,000
Salaries & wages expense 46,000
3-81
7. Closing Entries
Illustration 3-37
Illustration 3-37
3-82
8. Post-Closing Trial Balance

Illustration 3-38
3-83
LO 7
9. Reversing Entries
After preparing the financial statements and closing the books, a company may reverse some of the adjusting entries before recording the regular transactions of the next period.
3-84
Accounting Cycle Summarized

1. Enter the transactions of the period in appropriate journals. 2. Post from the journals to the ledger (or ledgers). 3. Take an unadjusted trial balance (trial balance). 4. Prepare adjusting journal entries and post to the ledger(s). 5. Take a trial balance after adjusting (adjusted trial balance). 6. Prepare the financial statements from the second trial balance. 7. Prepare closing journal entries and post to the ledger(s). 8. Take a trial balance after closing (post-closing trial balance). 9. Prepare reversing entries (optional) and post to the ledger(s).
3-85
Financial Statements of a Merchandising Company

Illustration 3-39
3-86
LO 7

Illustration 3-40
3-87
LO 7
Illustration 3-41
3-88
LO 7
APPENDIX
3A
CASH-BASIS ACCOUNTING VERSUS ACCRUAL-BASIS ACCOUNTING
Most companies use accrual-basis accounting

recognize revenue when it is earned and expenses in the period incurred,
without regard to the time of receipt or payment of cash. Under the strict cash-basis, companies

record revenue only when they receive cash, and record expenses only when they disperse cash.
Cash basis financial statements are not in conformity with GAAP.

LO 8 Differentiate the cash basis of accounting from the accrual basis of accounting.
3-89
APPENDIX
3A
Illustration: Quality Contractor signs an agreement to construct a garage for $22,000. In January, Quality begins construction, incurs costs of $18,000 on credit, and by the end of January delivers a finished garage to the buyer. In February, Quality collects $22,000 cash from the customer. In March, Quality pays the $18,000 due the creditors.
Illustration 3A-1
3-90
APPENDIX
3A
Illustration: Quality Contractor signs an agreement to construct a garage for $22,000. In January, Quality begins construction, incurs costs of $18,000 on credit, and by the end of January delivers a finished garage to the buyer. In February, Quality collects $22,000 cash from the customer. In March, Quality pays the $18,000 due the creditors.
Illustration 3A-2
3-91
APPENDIX
3A
Conversion From Cash Basis To Accrual Basis

Illustration: Dr. Diane Windsor, like many small business owners, keeps her accounting records on a cash basis. In the year 2010, Dr. Windsor received $300,000 from her patients and paid $170,000 for operating expenses, resulting in an excess of cash receipts over disbursements of $130,000 ($300,000 - $170,000). At January 1 and December 31, 2010, she has accounts receivable, unearned service revenue, accrued liabilities, and prepaid expenses as shown in Illustration 3A-5.
Illustration 3A-5
3-92
APPENDIX
3A

Illustration: Calculate service revenue on an accrual basis.
Illustration 3A-8
Illustration 3A-5
3-93
APPENDIX
3A

Illustration: Calculate operating expenses on an accrual basis.
Illustration 3A-11
Illustration 3A-5
3-94
APPENDIX
3A

Illustration 3A-12
3-95
LO 8
APPENDIX
3A
Theoretical Weaknesses of the Cash Basis

Todays economy is considerably more lubricated by credit than by cash. The accrual basis, not the cash basis, recognizes all aspects of the credit phenomenon. Investors, creditors, and other decision makers seek timely information about an enterprises future cash flows.
3-96
APPENDIX
3B
USING REVERSING ENTRIES
Illustration of Reversing EntriesAccruals

Illustration 3B-1
3-97
LO 9 Identifying adjusting entries that may be reversed.
APPENDIX
3B
Illustration of Reversing EntriesDeferrals

Illustration 3B-2
3-98
APPENDIX
3B
Summary of Reversing Entries

1. All accruals should be reversed. 2. All deferrals for which a company debited or credited the original cash transaction to an expense or revenue account should be reversed. 3. Adjusting entries for depreciation and bad debts are not reversed. Recognize that reversing entries do not have to be used. Therefore, some accountants avoid them entirely.
3-99
APPENDIX
3C
USING A WORKSHEET: THE ACCOUNTING CYCLE REVISITED
A company prepares a worksheet either on

columnar paper or within an electronic spreadsheet.
A company uses the worksheet to adjust

account balances and to prepare financial statements.
3-100
LO 10 Prepare a 10-column worksheet.
APPENDIX
3C
Worksheet Columns
A company prepares a worksheet either on

columnar paper or within an electronic spreadsheet.
3-101
APPENDIX
3C
Illustration 3C-1 Worksheet
3-102
LO 10
APPENDIX
3C
Preparing Financial Statements from a Worksheet

The Worksheet:
provides information needed for preparation of the financial statements. Sorts data into appropriate columns, which facilitates the preparation of the statements.
3-103
APPENDIX
3C

Illustration 3-39
3-104
LO 10
APPENDIX
3C

Illustration 3-40
3-105
LO 10
APPENDIX
3C
Illustration 3-41
3-106
LO 10
RELEVANT FACTS
International companies use the same set of procedures and records to keep track of transaction data. Thus, the material in Chapter 3 is the same under both GAAP and IFRS. Transaction analysis is the same under IFRS and GAAP but, as you will see in later chapters, different standards sometimes impact how transactions are recorded. Rules for accounting for specific events sometimes differ across countries. For example, European companies rely less on historical cost and more on fair value than U.S. companies. Despite the differences, the double-entry accounting system is the basis of accounting systems worldwide.
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RELEVANT FACTS
Both the IASB and FASB go beyond the basic definitions provided in this textbook for the key elements of financial statements, that is, assets, liabilities, equity, revenues, and expenses. A trial balance under IFRS follows the same format as shown in the textbook. Internal controls are a system of checks and balances designed to prevent and detect fraud and errors. While most companies have these systems in place, many have never completely documented them nor had an independent auditor attest to their effectiveness. Both of these actions are required under SOX. Enhanced internal control standards apply only to large public companies listed on U.S. exchanges.
3-108

Information in a companys first IFRS statements must: a. have a cost that does not exceed the benefits. b. be transparent. c. provide a suitable starting point.
d. All the above.
3-109

The transition date is the date: a. when a company no longer reports under its national standards. b. when the company issues its most recent financial statement under IFRS. c. three years prior to the reporting date.
d. None of the above.
3-110

When converting to IFRS, a company must: a. recast previously issued financial statements in accordance with IFRS. b. use GAAP in the reporting period but subsequently use IFRS. c. prepare at least three years of comparative statements.
d. use GAAP in the transition year but IFRS in the reporting year.
3-111
Copyright
3-112
4-1
Income Statement and Related Information

4-2
Learning Objectives
1. 2. 3. 4. 5. 6. 7. 8. Understand the uses and limitations of an income statement. Prepare a single-step income statement. Prepare a multiple-step income statement. Explain how to report irregular items. Explain intraperiod tax allocation. Identify where to report earnings per share information. Prepare a retained earnings statement. Explain how to report other comprehensive income.
4-3
Income Statement and Related Information
Income Statement
Usefulness Limitations Quality of Earnings
Format of the Income Statement

Elements Single-step Multiple-step Condensed income statements
Reporting Irregular Items

Discontinued operations Extraordinary items Unusual gains and losses Changes in accounting principles Changes in estimates Corrections of errors
Special Reporting Issues

Intraperiod tax allocation Earnings per share Retained earnings statement Comprehensive income
4-4
Income Statement
Usefulness
Evaluate past performance.
Predicting future performance.
Help assess the risk or uncertainty of achieving future cash flows.
4-5
LO 1 Understand the uses and limitations of an income statement.
Income Statement
Limitations
Companies omit items that cannot be measured reliably.
Income is affected by the accounting methods employed.
Income measurement involves judgment.
4-6
Income Statement
Quality of Earnings
Companies have incentives to manage income to meet or beat Wall Street expectations, so that

market price of stock increases and value of stock options increase.
Quality of earnings is reduced if earnings management results in information that is less useful for predicting future earnings and cash flows.
4-7

Elements of the Income Statement
Revenues Inflows or other enhancements of assets or settlements of its liabilities that constitute the entitys ongoing major or central operations. Examples of Revenue Accounts

Sales Fee revenue Interest revenue
Dividend revenue Rent revenue
4-8

Expenses Outflows or other using-up of assets or incurrences of liabilities that constitute the entitys ongoing major or central operations. Examples of Expense Accounts

Cost of goods sold Depreciation expense Interest expense
Rent expense Salary expense
4-9

Gains Increases in equity (net assets) from peripheral or incidental transactions. Losses - Decreases in equity (net assets) from peripheral or incidental transactions. Gains and losses can result from

4-10
sale of investments or plant assets, settlement of liabilities, write-offs of assets.

Single-Step Format
Single-Step Income Statement
Revenues Expenses Net Income
No distinction between Operating and Non-operating categories.
Income Statement (in thousands) Revenues: Sales Interest revenue Total revenue Expenses: Cost of goods sold Selling expense Administrative expense Interest expense Income tax expense Total expenses Net income Earnings per share 149,000 10,000 43,000 21,000 24,000 247,000 $ 55,000 $ 0.75 $ 285,000 17,000 302,000
SingleStep
4-11
LO 2 Prepare a single-step income statement.
E4-4: Prepare an income statement from the data below.
Single-Step Format
Income Statement For the year ended Dec. 31, 2012
Administrative expense: Officers' salaries Depreciation Cost of goods sold Rental revenue Selling expense: Transportation-out Sales commissions Depreciation Sales Income tax expense Interest expense 2,690 7,980 6,480 96,500 7,580 1,860 $ 4,900 3,960 63,570 17,230
Revenues: Sales Rental revenue Total revenues Expenses: Cost of goods sold Selling expense Administrative exense Interest expense Income tax expense Total expenses Net income $ 63,570 17,150 8,860 1,860 7,580 99,020 14,710 $ 96,500 17,230 113,730
4-12
Single-Step Format Review

The single-step income statement emphasizes a. the gross profit figure. b. total revenues and total expenses. c. extraordinary items more than it is emphasized in the multiple-step income statement. d. the various components of income from continuing operations.
4-13

Multiple-Step Income Statement
Separates operating transactions from nonoperating transactions.
Matches costs and expenses with related revenues. Highlights certain intermediate components of income that analysts use.
4-14
LO 3 Prepare a multiple-step income statement.
Multiple-Step Format
Intermediate Components of the Income Statement
1. Operating section 2. Nonoperating section 3. Income tax 4. Discontinued operations 5. Extraordinary items 6. Earnings per share
4-15
The presentation divides information into major sections.
1. Operating Section
Income Statement (in thousands) Sales Cost of goods sold Gross profit Operating expenses: Selling expenses Administrative expenses Total operating expense Income from operations Other revenue (expense): Interest revenue Interest expense Total other Income before taxes Income tax expense Net income $ 285,000 149,000 136,000 10,000 43,000 53,000 83,000 17,000 (21,000) (4,000) 79,000 24,000 55,000
2. Nonoperating Section 3. Income tax

4-16
Illustration (E4-4): Prepare an income statement from the data below.

Administrative expense: Officers' salaries Depreciation Cost of goods sold Rental revenue Selling expense: Transportation-out Sales commissions Depreciation Sales Income tax expense Interest expense 2,690 7,980 6,480 96,500 7,580 1,860 $ 4,900 3,960 63,750 17,230
Income Statement For the year ended Dec. 31, 2012 Sales Cost of goods sold Gross profit Operating Expenses: Selling expense Administrative exense Total operating expenses Income from operations Other revenue (expense): Rental revenue Interest expense Total other Income before tax Income tax expense Net income $ 17,230 (1,860) 15,370 22,110 7,580 14,530 17,150 8,860 26,010 6,740 $ 96,500 63,750 32,750
4-17
Multiple-Step Format Review

A separation of operating and non operating activities of a company exists in a. both a multiple-step and single-step income statement. b. a multiple-step but not a single-step income statement. c. a single-step but not a multiple-step income statement. d. neither a single-step nor a multiple-step income statement.
4-18

Companies are required to report irregular items in the financial statements so users can determine the long-run earning power of the company. Illustration 4-5
Number of Irregular Items Reported in a Recent Year by 500 Large Companies
4-19
LO 4 Explain how to report irregular items.

Irregular items fall into six categories
1. Discontinued operations. 2. Extraordinary items. 3. Unusual gains and losses. 4. Changes in accounting principle. 5. Changes in estimates. 6. Corrections of errors.
4-20

Discontinued Operations
Occurs when,
(a) company eliminates the

results of operations and cash flows of a component.
(b) there is no significant continuing involvement in that component. Amount reported net of tax.
4-21
Reporting Discontinued Operations

Illustration: KC Corporation had after tax income from continuing operations of $55,000,000 for the year. During the year, it disposed of its restaurant division at a pretax loss of $270,000. Prior to disposal, the division operated at a pretax loss of $450,000 for the year. Assume a tax rate of 30%. Prepare a partial income statement for KC.
Income from continuing operations Discontinued operations: Loss from operations, net of $135,000 tax Loss on disposal, net of $81,000 tax Total loss on discontinued operations Net income
4-22
$55,000,000 315,000 189,000 504,000 $54,496,000

Discontinued Operations are reported after Income from continuing operations.
Income Statement (in thousands) Sales Cost of goods sold Gross profit
Interest expense Total other Income before taxes Income tax expense Income from continuing operations Discontinued operations: Loss from operations, net of tax Loss on disposal, net of tax Total loss on discontinued operations Net income
$ 285,000 149,000 136,000

(21,000) (4,000) 79,000 24,000 55,000 315 189 504 $ 54,496
Previously labeled as Net Income.
Moved to
4-23
LO 4

Extraordinary items are nonrecurring material items that
differ significantly from a companys typical business activities. Extraordinary Item must be both of an

Unusual Nature and Occur Infrequently
Company must consider the environment in which it operates. Amount reported net of tax.
4-24
Reporting Extraordinary Items

Are these items Extraordinary?
(a) A large portion of a tobacco manufacturers crops are destroyed by a hail storm. Severe damage from hail storms in the locality where the manufacturer grows tobacco is rare. (b) A citrus grower's Florida crop is damaged by frost. (c) A company sells a block of common stock of a publicly traded company. The block of shares, which represents less than 10% of the publicly-held company, is the only security investment the company has ever owned.
4-25
YES
NO
YES

Are these items Extraordinary?
(d) A large diversified company sells a block of shares from its portfolio of securities which it has acquired for investment purposes. This is the first sale from its portfolio of securities. (e) An earthquake destroys one of the oil refineries owned by a large multi-national oil company. Earthquakes are rare in this geographical location. (f) A company experiences a material loss in the repurchase of a large bond issue that has been outstanding for 3 years. The company regularly repurchases bonds of this nature.
NO
YES
NO
4-26
LO 4

Illustration: KC Corporation had after tax income from continuing operations of $55,000,000 during the year. In addition, it suffered an unusual and infrequent pretax loss of $770,000 from a volcano eruption. The corporations tax rate is 30%. Prepare a partial income statement for KC Corporation beginning with income from continuing operations.
Income from continuing operations Extraordinary loss, net of $231,000 tax Net income ($770,000 x 30% = $231,000 tax)
4-27
$55,000,000 539,000 $54,461,000

Extraordinary Items are reported after Income from continuing operations.
Other revenue (expense): Interest revenue Interest expense Total other Income before taxes Income tax expense Income from continuing operations Extraordinary loss, net of tax Net income
$ 285,000 149,000 136,000
Previously labeled as Net Income. Moved to

4-28
17,000 (21,000) (4,000) 79,000 24,000 55,000 539 $ 54,461
LO 4

Illustration 4-8 Income Statement Presentation of Extraordinary Items
4-29
LO 4

Reporting when both Discontinued Operations and Extraordinary Items are present.
Income before taxes Income tax expense Income from continuing operations Discontinued operations: Loss from operations, net of tax Loss on disposal, net of tax Total loss on discontinued operations Income before extraordinary item Extraordinary loss, net of tax Net income
$ 285,000 149,000 136,000

79,000 24,000 55,000 315 189 504 54,496 539 $ 54,496
LO 4
Discontinued Operations Extraordinary Items
4-30
Reporting Irregular Items Review

Irregular transactions such as discontinued operations and extraordinary items should be reported separately in a. b. c. d. both a single-step and multiple-step income statement. a single-step income statement only. a multiple-step income statement only. neither a single-step nor a multiple-step income statement.
4-31

Unusual Gains and Losses
Material items that are unusual or infrequent, but not both, should be reported in a separate section just above Income from continuing operations before income taxes. Examples can include:

Write-downs of inventories Foreign exchange transaction gains and losses
The Board prohibits net-of-tax treatment for these items.
4-32

Illustration 4-9 Income Statement Presentation of Unusual Charges
4-33

Changes in Accounting Principles

Retrospective adjustment. Cumulative effect adjustment to beginning retained earnings. Approach preserves comparability. Examples include:

change from FIFO to average cost. change from the percentage-of-completion to the completed-contract method.
4-34

Change in Accounting Principle: Gaubert Inc. decided in
March 2012 to change from FIFO to weighted-average inventory pricing. Gauberts income before taxes, using the new weightedaverage method in 2012, is $30,000.
Pretax Income Data Illustration 4-10 Calculation of a Change in Accounting Principle
Illustration 4-11 Income Statement Presentation of a Change in Accounting Principle (Based on 30% tax rate)
4-35

Changes in Estimate

Accounted for in the period of change and future periods. Not handled retrospectively. Not considered errors or extraordinary items. Examples include:

Useful lives and salvage values of depreciable assets. Allowance for uncollectible receivables. Inventory obsolescence.
4-36
Change in Estimate Example

Change in Estimate: Arcadia HS, purchased equipment for
$510,000 which was estimated to have a useful life of 10 years with a salvage value of $10,000 at the end of that time. Depreciation has been recorded for 7 years on a straight-line basis. In 2012 (year 8), it is determined that the total estimated life should be 15 years with a salvage value of $5,000 at the end of that time.
Questions:
What is the journal entry to correct the prior years depreciation? Calculate the depreciation expense for 2012.
4-37

Equipment cost Salvage value Depreciable base Useful life (original) Annual depreciation
After 7 years
$510,000 First, establish NBV - 10,000 at date of change in estimate. 500,000 10 years $ 50,000 x 7 years = $350,000
Balance Sheet (Dec. 31, 2011) Fixed Assets: Equipment Accumulated depreciation Net book value (NBV)
4-38
$510,000 350,000 $160,000

Net book value Salvage value (new) Depreciable base Useful life remaining Annual depreciation Journal entry for 2012 Depreciation expense Accumulated depreciation
4-39
After 7 years
Depreciation Expense calculation for 2012.
$160,000 5,000 155,000 8 years $ 19,375
19,375 19,375

Corrections of Errors
Result from:

mathematical mistakes. mistakes in application of accounting principles. oversight or misuse of facts.
Corrections treated as prior period adjustments. Adjustment to the beginning balance of retained earnings.
4-40

Corrections of Errors: To illustrate, in 2013, Hillsboro Co.
determined that it incorrectly overstated its accounts receivable and sales revenue by $100,000 in 2010. In 2013, Hillboro makes the following entry to correct for this error (ignore income taxes). Retained earnings Accounts receivable 100,000 100,000
4-41

Intraperiod Tax Allocation
Relates the income tax expense to the specific items that give rise to the amount of the tax expense. Income tax is allocated to the following items: (1) Income from continuing operations before tax. (2) Discontinued operations. (3) Extraordinary items.
4-42
LO 5 Explain intraperiod tax allocation.

Extraordinary Gain: Schindler Co. has income before income tax and extraordinary item of $250,000. It has an extraordinary gain of $100,000 from a condemnation settlement received on one its properties. Assuming a 30 percent income tax rate.
Illustration 4-13
4-43

Extraordinary Loss: Schindler Co. has income before income tax and extraordinary item of $250,000. It has an extraordinary loss from a major casualty of $100,000. Assuming a 30 percent income tax rate.
Illustration 4-14
4-44
Example of Intraperiod Tax Allocation

Income Statement (in thousands) Sales Cost of goods sold $ 285,000 149,000
Note: losses reduce the total tax
Total other Income from cont. oper. before taxes Income tax expense Income from continuing operations Discontinued operations: Loss on operations, net of $135 tax Loss on disposal, net of $61 tax Total loss on discontinued operations Income before extraordinary item Extraordinary loss, net of $231 tax Net income
(4,000) 79,000 24,000 55,000 315 189 504 54,496 539 $ 53,957
Calculation of Total Tax $24,000 (135) (61) (231) $23,573
4-45

Earnings Per Share
Net income - Preferred dividends Weighted average number of shares outstanding

An important business indicator. Measures the dollars earned by each share of common stock. Must be disclosed on the the income statement.
4-46
LO 6 Identify where to report earnings per share information.

Earnings Per Share (BE4-8): In 2012, Hollis Corporation
reported net income of $1,000,000. It declared and paid preferred stock dividends of $250,000. During 2012, Hollis had a weighted average of 190,000 common shares outstanding. Compute Holliss 2012 earnings per share. Net income - Preferred dividends Weighted average number of shares outstanding $1,000,000 $250,000
190,000
4-47
= $3.95 per share
LO 6 Identify where to report earnings per share information.

Illustration 4-17
Divide by weightedaverage shares outstanding
EPS
4-48
LO 6

Retained Earnings Statement Increase

Decrease

Net income Change in accounting principle Error corrections
Net loss Dividends Change in accounting principles Error corrections
4-49
LO 7 Prepare a retained earnings statement.

Woods, Inc. Statement of Retained Earnings For the Year Ended December 31, 2012 Balance, January 1 Net income Dividends Balance, December 31 $ 1,050,000 360,000 (300,000) 1,110,000
Before issuing the report for the year ended December 31, 2012, you discover a $50,000 error (net of tax) that caused 2011 inventory to be overstated (overstated inventory caused COGS to be lower and thus net income to be higher in 2011). Would this discovery have any impact on the reporting of the Statement of Retained Earnings for 2012?
4-50

Woods, Inc. Statement of Retained Earnings For the Year Ended December 31, 2012 Balance, January 1 Prior period adjustment - error correction Balance, January 1 (restated) Net income Dividends Balance, December 31 $ 1,050,000 (50,000) 1,000,000 360,000 (300,000) 1,060,000
4-51

Restrictions on Retained Earnings
Disclosed

In notes to the financial statements. As Appropriated Retained Earnings.
4-52

Comprehensive Income
All changes in equity during a period except those resulting from investments by owners and distributions to owners. Includes:
all revenues and gains, expenses and losses reported in net income, and all gains and losses that bypass net income but affect stockholders equity.
4-53
LO 8 Explain how to report other comprehensive income.

Income Statement (in thousands) Sales Cost of goods sold Gross profit Operating expenses: Selling expenses Administrative expenses Total operating expense $ 285,000 149,000 136,000 10,000 43,000 53,000 83,000
Other Comprehensive Income
Unrealized gains and losses on available-forsale securities. Translation gains and losses on foreign currency. Plus others
Income from operations Other revenue (expense): Interest revenue 17,000 Interest expense (21,000) Total other (4,000) Income before taxes 79,000 Income tax expense 24,000 $ 55,000 Net income
4-54
Reported in Stockholders Equity
Special Reporting Issues Review

Gains and losses that bypass net income but affect stockholders' equity are referred to as a. comprehensive income. b. other comprehensive income. c. prior period income. d. unusual gains and losses.
4-55

Companies must display the components of other comprehensive income in one of three ways: 1. A second separate income statement; 2. A combined income statement of comprehensive income; or 3. As part of the statement of stockholders equity
4-56

Second income statement
Illustration 4-19
4-57
LO 8

Combined statement
V. Gill Inc. Combined Statement of Comprehensive Income For the Year Ended December 31, 2012 Sales revenue Cost of goods sold Gross profit Operating expenses Net income Unrealized holding gain, net of tax Comprehensive income $ 800,000 600,000 200,000 90,000 110,000 30,000 $ 140,000
4-58
LO 8

Statement of Stockholders Equity
Illustration 4-20
4-59

Balance Sheet Presentation
Illustration 4-21 Presentation of Accumulated Other Comprehensive Income in the Balance Sheet
Regardless of the display format used, the accumulated other comprehensive income of $90,000 is reported in the stockholders equity section of the balance sheet.
4-60
Special Reporting Issues Review

The FASB decided that the components of other comprehensive income must be displayed a. in a second separate income statement. b. in a combined income statement of comprehensive income. c. as a part of the statement of stockholders equity. d. Any of these options is permissible.
4-61
RELEVANT FACTS
Presentation of the income statement under GAAP follows either a single-step or multiple-step format. IFRS does not mention a singlestep or multiple-step approach. Extraordinary items are prohibited under IFRS. Under IFRS, companies must classify expenses by either nature or function. GAAP does not have that requirement, but the U.S. SEC requires a functional presentation. IFRS identifies certain minimum items that should be presented on the income statement. GAAP has no minimum information requirements. However, the SEC rules have more rigorous presentation requirements.
4-62
RELEVANT FACTS
IFRS does not define key measures like income from operations. SEC regulations define many key measures and provide requirements and limitations on companies reporting nonGAAP/IFRS information. GAAP does not require companies to indicate the amount of net income attributable to non-controlling interest. GAAP and IFRS follow the same presentation guidelines for discontinued operations, but IFRS defines a discontinued operation more narrowly. Both standard- setters have indicated a willingness to develop a similar definition to be used in the joint project on financial statement presentation.
4-63
RELEVANT FACTS
Both GAAP and IFRS have items that are recognized in equity as part of comprehensive income but do not affect net income. GAAP provides three possible formats for presenting this information: single income statement, combined statement of comprehensive income, in the statement of stockholders equity. Most companies that follow GAAP present this information in the statement of stockholders equity. IFRS allows a separate statement of comprehensive income or a combined statement. Under IFRS, revaluation of property, plant, and equipment, and intangible assets is permitted and is reported as other comprehensive income. The effect of this difference is that application of IFRS results in more transactions affecting equity but not net income.
4-64

Which of the following is not reported in an income statement under IFRS? a. Discontinued operations. b. Extraordinary items. c. Cost of goods sold. d. Income tax.
4-65

Which of the following statements is correct regarding income reporting under IFRS? a. IFRS does not permit revaluation of property, plant, and equipment, and intangible assets. b. IFRS provides the same options for reporting comprehensive income as GAAP. c. Companies must classify expenses either by nature or function. statement.
d. IFRS provides a definition for all items presented in the income
4-66

Which of the following is not an acceptable way of displaying the components of other comprehensive income under IFRS? a. Within the statement of retained earnings. b. Second income statement. c. Combined statement of comprehensive income. d. All of the above are acceptable.
4-67
Copyright
4-68
5-1
Balance Sheet and Statement of Cash Flows

5-2
Learning Objectives
1. 2. 3. 4. 5. 6. 7. 8. 9.
5-3
Explain the uses and limitations of a balance sheet. Identify the major classifications of the balance sheet. Prepare a classified balance sheet using the report and account formats. Indicate the purpose of the statement of cash flows. Identify the content of the statement of cash flows. Prepare a statement of cash flows. Understand the usefulness of the statement of cash flows. Determine which balance sheet information requires supplemental disclosure. Describe the major disclosure techniques for the balance sheet.
Balance Sheet and Statement of Cash Flows
Balance Sheet
Usefulness Limitations Classification

Purpose Content and format Preparation Usefulness
Additional Information
Supplemental disclosures Techniques of disclosure
5-4
Balance Sheet
Balance Sheet, also referred to as the statement of
financial position: 1. Reports assets, liabilities, and equity at a specific date. 2. Provides information about resources, obligations to creditors, and equity in net resources. 3. Helps in predicting amounts, timing, and uncertainty of future cash flows.
5-5
LO 1 Explain the uses and limitations of a balance sheet.
Balance Sheet
Usefulness of the Balance Sheet

Computing rates of return. Evaluating the capital structure. Assess risk and future cash flows. Analyze the companys:

Liquidity, Solvency, and Financial flexibility.

5-6
Balance Sheet
Limitations of the Balance Sheet
Most assets and liabilities are reported at historical cost. Use of judgments and estimates. Many items of financial value are omitted.
5-7
Balance Sheet
Classification
5-8
LO 2 Identify the major classifications of the balance sheet.
Balance Sheet
Classification
Illustration 5-1
In practice you usually see little departure from these major subdivisions.
5-9
Classification in the Balance Sheet

Current Assets
Cash and other assets a company expects to convert into cash, sell, or consume either in one year or in the operating cycle, whichever is longer.
Illustration 5-2
5-10
Classification in the Balance Sheet Review

The correct order to present current assets is a. Cash, accounts receivable, prepaid items, inventories. b. Cash, accounts receivable, inventories, prepaid items. c. Cash, inventories, accounts receivable, prepaid items. d. Cash, inventories, prepaid items, accounts receivable.
5-11
Balance Sheet Current Assets

Cash

Generally any monies available on demand. Cash equivalents - short-term highly liquid investments that mature within three months or less. Restrictions or commitments must be disclosed.
Illustration 5-3
5-12
LO 2

Cash
Illustration 5-4 Balance SheetRestricted Cash
5-13

Short-Term Investments
Portfolios
Held-toMaturity Trading Availablefor-Sale
Type
Debt Debt or Equity Debt or Equity
Valuation
Amortized Cost Fair Value Fair Value
Classification
Current or Noncurrent Current Current or Noncurrent
5-14

Short-Term Investments
Illustration 5-5 Balance Sheet Presentation of Investments in Securities
5-15

Receivables
Major categories of receivables should be shown in the balance sheet or the related notes. A company should clearly identify

Anticipated loss due to uncollectibles. Amount and nature of any nontrade receivables. Receivables used as collateral.
5-16

Receivables
Illustration 5-6 Balance Sheet Presentation of Receivables
5-17

Inventories
Disclose:

Basis of valuation (e.g., lower-of-cost-or-market). Cost flow assumption (e.g., FIFO or average cost).
Illustration 5-6
5-18
LO 2

Prepaid Expenses
Payment of cash, that is recorded as an asset because service or benefit will be received in the future.
Cash Payment
BEFORE
Expense Recorded
Prepayments often occur in regard to:

5-19
insurance supplies advertising
rent taxes

Prepaid Expenses
Illustration 5-9
5-20

Current Assets - Summary
Cash and other assets a company expects to

Balance Sheet (in thousands) Current assets Cash ST Investments Accounts receivable Inventory Prepaid expenses Total current assets Investments: Invesment in ABC bonds Investment in UC Inc. 321,657 253,980 $ 285,000 140,000 777,000 402,000 170,000 1,774,000
convert into cash, sell, or consume
either in one year or in the operating cycle, whichever is longer.
5-21

Non-Current Assets
Long-term Investments
1. Securities (bonds, common stock, or long-term notes). 2. Tangible fixed assets not currently used in operations (land held for speculation). 3. Special funds (sinking fund, pension fund, or plant expansion fund. 4. Non-consolidated subsidiaries or affilated companies.
5-22
Balance Sheet Noncurrent Assets

Long-Term Investments
Portfolios
Held-toMaturity Trading Availablefor-Sale
Type
Debt Debt or Equity Debt or Equity
Valuation
Amortized Cost Fair Value Fair Value
Classification
Current or Noncurrent Current Current or Noncurrent
5-23

Securities

Balance Sheet (in thousands) Current assets Cash $ 285,000
Investments: Invesment in ABC bonds Investment in UC Inc. Notes receivable Land held for speculation Sinking fund Pension fund Cash surrender value Investment in Uncon. Sub. Total investments Property, Plant, and Equip. Building Land 1,375,778 975,000 321,657 253,980 150,000 550,000 225,000 653,798 84,321 457,836 2,696,592
bonds, stock, and long-term notes
For marketable securities, managements intent determines current or noncurrent classification.

5-24
LO 2

Fixed Assets
Investments: Invesment in ABC bonds Investment in UC Inc. Notes receivable Land held for speculation Sinking fund Pension fund Cash surrender value Investment in Uncon. Sub. Total investments Property, Plant, and Equip. Building
5-25
321,657 253,980 150,000 550,000 225,000 653,798 84,321 457,836 2,696,592 1,375,778 975,000
Land held for speculation
LO 2
Land

Special Funds

Investments: Invesment in ABC bonds Investment in UC Inc. Notes receivable Land held for speculation Sinking fund Pension fund Cash surrender value Investment in Uncon. Sub. Total investments Property, Plant, and Equip. Building
5-26
321,657 253,980 150,000 550,000 225,000 653,798 84,321 457,836 2,696,592 1,375,778 975,000
Sinking fund Pensions fund Cash surrender value of life insurance
LO 2
Land

Investments: Invesment in ABC bonds Investment in UC Inc. Notes receivable Land held for speculation Sinking fund 321,657 253,980 150,000 550,000 225,000 653,798 84,321 457,836 2,696,592 1,375,778 975,000
Nonconsolidated Subsidiaries or Affiliated Companies

5-27
Pension fund Cash surrender value Investment in Uncon. Sub. Total investments Property, Plant, and Equip. Building
LO 2
Land

Illustration 5-10 Balance Sheet Presentation of Long-Term Investments
5-28

Property, Plant, and Equipment
Tangible long-lived assets used in the regular operations of the business.
Physical property such as land, buildings, machinery, furniture, tools, and wasting resources (minerals).
With the exception of land, a company either depreciates (e.g., buildings) or depletes (e.g., oil reserves) these assets.
5-29

Balance Sheet (in thousands)

Tangible assets used in the regular operations of the business.
Current assets Cash $ 285,000
Total investments Property, Plant, and Equip. Building Land Machinery and equipment Capital leases Leasehold improvements Accumulated depreciation Total PP&E Intangibles Goodwill Patents Trademarks
2,696,592 1,375,778 975,000 234,958 384,650 175,000 (975,000) 2,170,386 3,000,000 177,000 40,000
5-30

Illustration 5-11 Balance Sheet Presentation of Property, Plant, and Equipment
5-31

Intangibles
Lack physical substance and are not financial instruments.
Limited life intangibles amortized. Indefinite-life intangibles tested for impairment.
Total PP&E Intangibles Goodwill Patents Trademark Franchises Copyright Total intangibles Other assets Prepaid pension costs Deferred income tax Total other Total Assets
2,170,386 2,000,000 177,000 40,000 125,000 55,000 2,397,000 133,000 40,000 173,000 $ 9,210,978
LO 2
5-32

Intangibles (BE5-6): Patrick Corporation adjusted trial balance
contained the following asset accounts at December 31, 2012: Prepaid Rent $12,000; Goodwill $50,000; Franchise Fees Receivable $2,000; Franchises $47,000; Patents $33,000; Trademarks $10,000. Prepare the intangible assets section of the balance sheet. Intangibles Goodwill Franchises Patents Trademarks Total
5-33
$ 50,000 47,000 33,000 10,000 $140,000

Intangible Assets
Illustration 5-12 Balance Sheet Presentation of Intangible Assets
5-34

Other Assets
Items vary in practice. Can include:

Long-term prepaid expenses Non-current receivables Assets in special funds Property held for sale Restricted cash or securities
5-35

Other Assets
This section should include only unusual items sufficiently different from assets in the other categories.
Total PP&E Intangibles Goodwill Patents Trademark Franchises Copyright Total intangibles Other assets Prepaid pension costs Deferred income tax Total other Total Assets
2,170,386 2,000,000 177,000 40,000 125,000 55,000 2,397,000 133,000 40,000 173,000 $ 9,210,978
LO 2
5-36

Current Liabilities
Obligations that a company reasonably expects to liquidate either through the use of current assets or the creation of other current liabilities.
Balance Sheet (in thousands) Current liabilities Notes payable Accounts payable Accrued compensation Unearned revenue Income tax payable Current maturities LT debt Total current liabilities Long-term liabilities Long-term debt Obligations capital lease Deferred income taxes Total long-term liabilities Stockholders' equity $ 233,450 131,800 43,000 17,000 23,400 121,000 569,650 979,500 345,800 77,909 1,403,209
5-37

Current Liabilities
Illustration 5-13 Balance Sheet Presentation of Current Liabilities
5-38

Long-Term Liabilities
Obligations that a company does not reasonably expect to liquidate within the normal operating cycle. All covenants and restrictions must be disclosed.
5-39
Balance Sheet (in thousands) Current liabilities Notes payable Accounts payable Accrued compensation Unearned revenue Income tax payable Current maturities LT debt Total current liabilities Long-term liabilities Long-term debt Obligations capital lease Deferred income taxes Total long-term liabilities Stockholders' equity $ 233,450 131,800 43,000 17,000 23,400 121,000 569,650 979,500 345,800 77,909 1,403,209
Balance Sheet Long-Term Liabilities

Long-Term Liabilities (BE5-9): Included in Adams Companys
December 31, 2012, trial balance are the following accounts: Accounts Payable $220,000; Pension Asset/Liability $375,000; Discount on Bonds Payable $29,000; Unearned Revenue $41,000; Bonds Payable $400,000; Salaries and Wages Payable $27,000; Interest Payable $12,000; Income Taxes Payable $29,000. Prepare the long-term liabilities section of the balance sheet. Long-term liabilities Pension Asset/liability Bonds payable Discount on bonds payable Total
5-40
$375,000 400,000 (29,000) 746,000
Balance Sheet Long-Term Liabilities

Non-Current Liabilities
Illustration 5-14 Balance Sheet Presentation of Non-Current Liabilities
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Balance Sheet Owners Equity

Owners Equity
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Balance Sheet Owners Equity

Owners Equity
Illustration 5-15 Balance Sheet Presentation of Stockholders Equity
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Account
(a) Investment in preferred stock (b) Treasury stock (c) Common stock (d) Cash dividends payable (e) Accumulated depreciation (f) Interest payable (g) Deficit (h) Trading securities (i) Unearned revenue
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Classification
(a) Current asset/Investment (b) Stockholders Equity (c) Stockholders Equity (d) Current liability (e) Contra-asset (f) Current liability (g) Stockholders Equity (h) Current asset (i) Current liability
Balance Sheet Format

Classified Balance Sheet

Account form Report form
Accounting Trends and Techniques2009 (New York: AICPA) indicates that all of the 500 companies surveyed use either the report form (438) or the account form (62), sometimes collectively referred to as the customary form.
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LO 3 Prepare a classified balance sheet using the report and account formats.

Account Form
Illustration 5-16
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LO 3 Prepare a classified balance sheet using the report and account formats.
Report Form
LO 3

One of the three basic objectives of financial reporting is
assessing the amounts, timing, and uncertainty of cash flows.
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LO 4 Indicate the purpose of the statement of cash flows.

Purpose of the Statement of Cash Flows
To provide relevant information about the cash receipts and cash payments of an enterprise during a period. The statement provides answers to the following questions: 1. 2. 3.
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Where did the cash come from? What was the cash used for? What was the change in the cash balance?
LO 4 Indicate the purpose of the statement of cash flows.

Content and Format
Three different activities:
Operating,
Investing,
Financing
Illustration 5-17 Basic Format of Cash Flow Statement
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LO 5 Identify the content of the statement of cash flows.

Content and Format
Operating
Cash inflows and outflows that enter into the determination of net income.
Investing
Cash inflows and outflows from non-current assets.
Financing
Cash inflows and outflows from non-current liabilities and equity.
The statements value is that it helps users evaluate liquidity, solvency, and financial flexibility.
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Illustration 5-18
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Preparation of the Statement of Cash Flows

Sources of Information
Information obtained from several sources: (1) comparative balance sheets, (2) the current income statement, and (3) selected transaction data.
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LO 6 Prepare a basic statement of cash flows.

Statement of Cash Flows: On January 1, 2012, in its first
year of operations, Telemarketing Inc. issued 50,000 shares of $1 par value common stock for $50,000 cash. The company rented its office space, furniture, and telecommunications equipment and performed marketing services throughout the first year. In June 2012 the company purchased land for $15,000. Illustration 5-19 shows the companys comparative balance sheets at the beginning and end of 2012.
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Illustration 5-19
Illustration 5-20
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LO 6

Preparing the Statement of Cash Flows
Determine:
1. Cash provided by (or used in) operating activities. 2. Cash provided by or used in investing and financing activities. 3. Determine the change (increase or decrease) in cash during the period. 4. Reconcile the change in cash with the beginning and the ending cash balances.
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Illustration 5-19 Illustration 5-20
Cash provided by operating activities
Illustration 5-21
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Illustration 5-19 Illustration 5-20

Next, the company determines its investing and financing activities.

Statement of Cash Flows (BE 5-12): Keyser Beverage
Company reported the following items in the most recent year.
Activity Net income Dividends paid Increase in accounts receivable Increase in accounts payable Purchase of equipment Depreciation expense Issue of notes payable $40,000 5,000 10,000 7,000 8,000 4,000 20,000 Operating Financing
Operating Operating Investing Operating Financing
Required: Compute net cash provided by operating activities.

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Statement of Cash Flows (BE 5-12)
Statement of Cash Flow (in thousands) Operating activities Net income Increase in accounts receivable Increase in accounts payable Depreciation expense Cash flow from operations Investing activities Purchase of equipment Financing activities Proceeds from notes payable Dividends paid Cash flow from financing Increase in cash
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$ 40,000 (10,000) 5,000 40,000 75,000 (8,000) 20,000 (5,000) 15,000 $ 82,000
Noncash credit to revenues. Noncash charge to expenses.
Statement of Cash Flows Review

In preparing a statement of cash flows, which of the following transactions would be considered an investing activity? a. b. c. d. Sale of equipment at book value Sale of merchandise on credit Declaration of a cash dividend Issuance of bonds payable at a discount receivable.
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Significant Noncash Activities
Significant financing and investing activities that do not affect cash are reported in either a separate schedule at the bottom of the statement of cash flows or in the notes. Examples include:

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Issuance of common stock to purchase assets. Conversion of bonds into common stock. Issuance of debt to purchase assets. Exchanges on long-lived assets.
Illustration 5-23 Comprehensive Statement of Cash Flows
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Usefulness of the Statement of Cash Flows

Without cash, a company will not survive. Cash flow from Operations:
High amount - company able to generate sufficient cash to pay its bills. Low amount - company may have to borrow or issue equity securities to pay bills.
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LO 7 Understand the usefulness of the statement of cash flows.

Financial Liquidity
Current Cash Debt Coverage Ratio Net Cash Provided by Operating Activities Average Current Liabilities
Ratio indicates whether the company can pay off its current liabilities from its operations. A ratio near 1:1 is good.
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Financial Liquidity
Cash Debt Coverage Ratio Net Cash Provided by Operating Activities Average Total Liabilities
This ratio indicates a companys ability to repay its liabilities from net cash provided by operating activities, without having to liquidate the assets employed in its operations.
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Free Cash Flow
Illustration 5-28
The amount of discretionary cash flow a company has for purchasing additional investments, retiring its debt, purchasing treasury stock, or simply adding to its liquidity.
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Usefulness of the Statement of Cash Flows Review

The current cash debt coverage ratio is often used to assess a. financial flexibility. b. liquidity. c. profitability. d. solvency.
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Supplemental Disclosures
Four types of information that are supplemental to account titles and amounts presented in the balance sheet:
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LO 8 Determine which balance sheet information requires supplemental disclosure.
Techniques of Disclosure

Parenthetical Explanations Notes Cross-Reference and Contra Items Supporting Schedules Terminology
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LO 9 Describe the major disclosure techniques for the balance sheet.
APPENDIX
5A
Ratio AnalysisA Reference
Using Ratios to Analyze Performance

Analysts and other interested parties can gather qualitative information from financial statements by examining relationships between items on the statements and identifying trends in these relationships.
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LO 10 Identify the major types of financial ratios and what they measure.
APPENDIX
5A

Illustration 5A-1 A Summary of Financial Ratios
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APPENDIX
5A

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APPENDIX
5A

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APPENDIX
5B
Specimen Financial Statements: The Procter & Gamble Company
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APPENDIX
5B
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APPENDIX
5B
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APPENDIX
5B
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APPENDIX
5B
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APPENDIX
5B
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APPENDIX
5B
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RELEVANT FACTS
IFRS recommends but does not require the use of the title statement of financial position rather than balance sheet. IFRS requires a classified statement of financial position except in very limited situations. IFRS follows the same guidelines as this textbook for distinguishing between current and noncurrent assets and liabilities. However under GAAP, public companies must follow SEC regulations, which require specific line items. In addition, specific GAAP standards mandate certain forms of reporting this information. Under IFRS, current assets are usually listed in the reverse order of liquidity. For example, under GAAP cash is listed first, but under IFRS it is listed last.
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RELEVANT FACTS
IFRS has many differences in terminology that you will notice in this textbook. Both IFRS and GAAP require disclosures about (1) accounting policies followed, (2) judgments that management has made in the process of applying the entitys accounting policies, and (3) the key assumptions and estimation uncertainty that could result in a material adjustment to the carrying amounts of assets and liabilities within the next financial year. Comparative prior period information must be presented and financial statements must be prepared annually. Use of the term reserve is discouraged in GAAP, but there is no such prohibition in IFRS.
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Current assets under IFRS are listed generally: a. by importance. b. in the reverse order of their expected conversion to cash. c. by longevity.
d. alphabetically.
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Companies that use IFRS: a. may report all their assets on the statement of financial position at fair value. b. are not allowed to net assets (assets 2 liabilities) on their statement of financial positions. c. may report noncurrent assets before current assets on the statement of financial position. d. do not have any guidelines as to what should be reported on the statement of financial position.
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A company has purchased a tract of land and expects to build a production plant on the land in approximately 5 years. During the 5 years before construction, the land will be idle. Under IFRS, the land should be reported as: a. land expense. b. property, plant, and equipment. c. an intangible asset.
d. a long-term investment.
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Copyright
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GlossaryChapter 1
Accounting Principles Board (APB) Private standard-setting organization from 1959 to 1973, whose mission was to develop an overall conceptual framework. Its official pronouncements, called APB Opinions, were to be based mainly on research studies and be supported by reasons and analysis. The APB issued 31 opinions in its lifetime. (p. 9). Accounting Research Bulletins Fifty-one bulletins from the Committee on Accounting Procedure (CAP) during the years 1939 to 1959, issued to deal with accounting problems as they arose. Subsequently, the AICPA created the Accounting Principles Board to provide a structured body of accounting principles. (p. 9). Accounting Standards Update The process by which a new FASB standard, staff position, etc., is included in the FASB Codification. The update includes the background and basis for conclusions for the new pronouncement in a common format, regardless of the form in which such guidance may have been issued. Updates are also issued for amendments to the SEC content in the Codification. (p. 14). accrual-basis accounting Accounting approach, in which a company records events that change its financial statements in the periods in which the events occur, rather than only in the periods in which it receives or pays cash. Thus, a company recognizes revenues when it earns them rather than when it receives cash, and it recognizes expenses when it incurs them rather than when it pays them. (p. 7). American Institute of Certified Public Accountants (AICPA) The national professional organization of practicing Certified Public Accountants (CPAs), whose various committees and boards have been an important contributor to the development of GAAP. (p. 9). APB Opinions The official pronouncements of the Accounting Principles Board, intended to be based mainly on research studies and be supported by reasons and analysis. Between its inception in 1959 and its dissolution in 1973, the APB issued 31 opinions. (p. 9). Auditing Standards Board The arm of the AICPA that had been responsible for developing auditing standards. The Public Company Accounting Oversight Board, established by the Sarbanes-Oxley Act, now oversees the development of auditing standards. (p. 13). Committee on Accounting Procedure (CAP) Committee established by the AICPA in 1939 at the urging of the SEC to deal with accounting problems. The CAP issued 51 Accounting Research Bulletins and was replaced by the Accounting Principles Board in 1959. (p. 9). decision-usefulness Approach that requires that financial reporting be useful to investors by helping them assess (1) the companys ability to generate net cash inflows and (2) managements ability to protect and enhance the capital providers investments. (p. 6). Emerging Issues Task Force (EITF) Group created in 1984 by the FASB to reach a consensus on how to account for new and unusual financial transactions that might create differing financial reporting practices. The FASB reviews and approves all EITF consensuses, and the SEC views consensus solutions as preferred accounting. (p. 12). entity perspective The view that companies are distinct and separate from their owners (present shareholders). (p. 6). expectations gap The difference between what the public thinks accountants should do and what accountants think they can do. (p. 19). financial accounting The accounting process that culminates in the preparation of financial reports for use by both internal and external parties. (p. 4). Financial Accounting Standards Board (FASB) The major organization of the standard-setting structure for financial accounting. Its mission is to establish and improve standards of financial accounting and reporting for the guidance and education of the public. The FASB consists of five members, appointed for five-year terms by the Financial Accounting Foundation. Standards issued by the FASB are considered generally accepted accounting principles (GAAP). (p. 10). Financial Accounting Standards Board Codification (Codification) Developed by the FASB, it provides in one place all the authoritative literature related to a particular topic. (p. 14). Financial Accounting Standards Board Codification Research System (CRS) An online, real-time database that provides easy access to the Codification, through a topically organized structure, subdivided into topics, subtopics, sections, and paragraphs, using a numerical index system. (p. 14). financial reporting Reporting of financial information other than in formal financial statements. Examples include the presidents letter or supplementary schedules in the corporate annual report, prospectuses,
reports filed with government agencies, news releases, managements forecasts, and social or environmental impact statements. (p. 4). financial statements The principal means through which a company communicates its financial information. These statements reflect the collection, tabulation, and final summarization of the accounting data. The statements most frequently provided are (1) the balance sheet, (2) the income statement, (3) the statement of cash flows, and (4) the statement of owners or stockholders equity. Note disclosures are an integral part of a companys financial statements. (p. 4). generally accepted accounting principles (GAAP) The common set of accounting standards and procedures, for which either an authoritative accounting rule-making body has established a principle of reporting in a given area, or over time, a given practice has been accepted as appropriate because of its universal application. (p. 7). general-purpose financial statements Provide financial reporting information to a wide variety of users at the least cost. (p. 5). International Accounting Standards Board (IASB) The organization, based in London, that sets accounting standards accepted for international use. Although many of these international standards are similar to U.S. GAAP, the FASB and the IASB are currently working on a convergence project to result in one set of high-quality standards. (p. 20). International Financial Reporting Standards (IFRS) All the accounting rules accepted for international use, issued by the International Accounting Standards Board (p. 20). interpretations Statements issued by the FASB that modify or extend existing standards. Interpretations have the same authority as standards for purposes of determining GAAP. (p. 12). objective of financial reporting Goal for financial accounting and reporting, established by the accounting profession, which is to provide information about the reporting entity that is useful to present and potential to equity investors, lenders, and other creditors in decisions about providing resources to the entity. (p. 5). Public Company Accounting Oversight Board (PCAOB) Organization established by the SarbanesOxley Act of 2002 that has oversight and enforcement authority for accounting practices and that establishes auditing, quality control, and independence standards and rules. (p. 18). Sarbanes-Oxley Act of 2002 Legislation, enacted by the U.S. Congress, intended to combat accounting fraud, curb poor reporting practices, and make sweeping changes to the institutional structure of the accounting profession. (p. 18). Securities and Exchange Commission (SEC) Federal agency established to help develop and standardize financial information presented to stockholders. It administers the Securities Exchange Act of 1934 and several other acts. Most companies that issue securities to the public are required to file audited financial statements with the SEC. The SEC also has broad powers to prescribe the accounting practices and standards to be employed by companies that fall within its jurisdiction. (p. 8). staff positions Issued by the FASB, these provide interpretive guidance and also minor amendments to standards and interpretations. (p. 12). Standards Statement Statements issued by the FASB that are considered GAAP and thereby binding in accounting practice. These statements go through a rigorous due process system (discussion memo, public hearing, exposure draft). The passage of a new Standards Statement requires the support of three of the five board members. (p. 11). Statement of Financial Accounting Concepts A series of statements by the FASB that set forth fundamental objectives and concepts that the Board uses in developing future standards of financial accounting and reporting. Unlike a Standards Statement, these statements of concepts do not establish GAAP. However, this cohesive set of interrelated concepts is intended to be a conceptual framework that will serve as tools for solving existing and emerging problems in a consistent manner. (p. 12). Wheat Committee The Study Group on Establishment of Accounting Principles, chaired by Francis Wheat, that examined the organization and operation of the Accounting Principles Board and determined the changes needed to attain better productivity and more timely correction of accounting abuses. The Study Group submitted its recommendations to the AICPA Council in the spring of 1972, which adopted the recommendations in total and implemented them by early 1973. (p. 10).
GlossaryChapter 2
assumption One of the parts in the third level of the conceptual framework; a concept that the accounting profession assumes as foundational for the financial accounting structure. There are four basic assumptions: (1) economic entity, (2) going concern, (3) monetary unit, and (4) periodicity. (p. 56). comparability An enhancing qualitative characteristic of accounting information, which describes information that is measured and reported in a similar manner for different companies. Comparability enables users to identify the real similarities and differences in economic activities between companies. (p. 52). completeness One of the ingredients of the fundamental quality of faithful representation. Completeness means that all the information necessary for faithful representation is provided. (p. 51). conceptual framework For the accounting profession, a coherent system of objectives and fundamentals established by the FASB, which determine the nature, function, and limits of financial accounting and which lead to consistent accounting standards. (p. 44). confirmatory value One of the ingredients of the fundamental quality of relevance, it helps to confirm or correct prior expectations based on previous evaluations of financial reporting information. (p. 49). conservatism The convention in accounting that dictates that when in doubt, choose the solution that will be least likely to overstate assets and income. The conceptual framework indicates that prudence or conservatism is generally in conflict with the quality of neutrality, because being prudent or conservative can lead to bias in the reported financial position and financial performance. (p. 64)(n)). consistency An aspect of comparable information, which indicates that a company applied the same accounting treatment to similar events from period to period. A company can change methods, but it must first demonstrate that the newly adopted method is preferable to the old and then must disclose in the financial statements the nature and effect of the accounting change. (p. 52). cost constraint (cost-benefit relationship) An accounting constraint that requires that the costs of providing financial information be weighed against the benefits that can be derived from using it. The constraint applies to informational requirements established by standard-setting bodies and governmental agencies as well as to companies reporting financial information. (p. 63). earned (revenue) Revenue is considered earned when the company substantially accomplishes what it must do to be entitled to the benefits represented by the revenues. Generally, an objective test, such as a sale, indicates the point at which a company recognizes revenue and verifies the amount of revenue earned. (p. 60). economic entity assumption An assumption that economic activity can be identified with a particular unit of accountability, by keeping an enterprises economic activity separate and distinct from that of its owners and any other business unit. The entity assumption refers to economic, rather than legal, entities. (p. 56). elements, basic Definitions of the items that make up any theoretical structure. For accounting, the basic elements are the many terms with distinctive and specific meanings. There are ten basic accounting elements: assets, liabilities, equity, investments by owners, distributions to owners, comprehensive income, revenues, expenses, gains, and losses. These terms constitute the language of business and accounting. (p. 54). expense recognition principle Accounting principle that dictates that the recognition of expenses is related to net changes in assets and earning revenues, that is, let the expense follow the revenues. (p. 61). fair value The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. (p. 58). fair value option The choice allowed by the FASB to use fair value in the financial statements as the basis of measurement for financial assets and liabilities. Under the fair value option, the item is recorded at fair value at each reporting date, and unrealized holding gains or losses are reported as part of net income. (p. 59). fair value principle GAAP-based principle that calls for the use of fair value measurements in the financial statements. (p. 58). faithful representation One of the qualitative characteristics of accounting information, which indicates that a companys accounting numbers and descriptions match what really existed or happened. (p. 51). financial statements The structured means of communicating financial information, through the balance sheet, income statement, statement of cash flows, and statement of owners equity. (p. 62). free from error View that information that is accurate will be more representationally faithful. (p. 51).
full disclosure principle Accounting principle that dictates that in deciding what information to report, companies follow the general practice of providing information that is of sufficient importance to influence the judgment and decisions of an informed user. It recognizes that the nature and amount of information included in financial reports reflects a series of judgmental trade-offs between sufficient detail that makes a difference to users, sufficient condensation to make the information understandable, and the costs and benefits of providing the information. (p. 62). general-purpose financial reporting The format for providing information to decision-makers at the least cost. (p. 47). going concern assumption Accounting assumption that a company will continue in operation for the foreseeable future. Only in situations in which liquidation appears imminent is the assumption inapplicable. (p. 57). historical cost principle An accepted accounting principle that companies account for and report most assets and liabilities on the basis of acquisition price. Historical cost is verifiable and neutral and therefore contributes to reliability. (p. 58). industry practices Peculiarities of some industries and business concerns that cause variations from basic accounting theory or practice. For example, agricultural companies often report crops at fair value because it is costly to develop accurate cost figures on individual crops. (p. 63). matching principle Accounting principle that dictates that efforts (expenses) be matched with accomplishment (revenues) whenever it is reasonable and practicable to do so. This linking of expense recognition to revenue recognition is popularly expressed as, Let the expense follow the revenues. (p. 61n). materiality A company-specific aspect of relevance, an item is said to be material if its inclusion or omission would influence or change the judgment of a reasonable person; it is immaterial, and therefore irrelevant, if it would have no impact on a decision-maker. The point involved is one of relative size and importance; that is, both quantitative and qualitative factors should be considered. (p. 49). monetary unit assumption Accounting assumption that money is the common denominator of economic activity and provides an appropriate basis for accounting measurement and analysis. (p. 57). neutrality One of the ingredients of the fundamental quality of faithful representation, neutrality indicates that a company cannot select information to favor one set of interested parties over another. Unbiased information must be the overriding consideration. (p. 51). notes to financial statements A set of disclosures in a companys financial statements that further explain the items presented in the main body of the statements. The additional information provided in the notes does not have to be quantifiable, nor does it need to qualify as an accounting element. Notes to the financial statements are considered an integral part of the statements. (p. 62). objective of financial reporting Goal for financial accounting and reporting, established by the accounting profession, which is to provide information about the reporting entity that is useful to present and potential to equity investors, lenders, and other creditors in decisions about providing resources to the entity. (p. 47). period costs Costs that attach to a specific accounting period. Examples are officers salaries and other administrative expenses. Companies charge off such period costs in the immediate period, even though benefits associated with these costs may occur in the future. Period costs are not included as part of inventory cost; instead, they are matched with revenue of a specific time period and expensed as incurred. (p. 61). periodicity (time period) assumption Accounting assumption that implies that a company can divide its economic activities into artificial time periods. These time periods vary, but the most common are monthly, quarterly, and yearly. (p. 57). predictive value One characteristic of relevant information, indicating that information must help users predict the ultimate outcome of past, present, and future events. (p. 49). principles of accounting One of the parts in the third level of the conceptual framework, which details recognition and measurement concepts. The accounting profession generally uses four basic principles of accounting to record transactions: (1) measurement, (2) revenue recognition, (3) expense recognition, and (4) full disclosure. (p. 58). product costs Costs that attach to a specific product. Examples are material, labor, and overhead. Companies carry product costs into future periods if they recognize the revenue from the product in subsequent periods. (p. 61). prudence The convention in accounting that dictates that when in doubt, choose the solution that will be least likely to overstate assets and income. The conceptual framework indicates that prudence or
conservatism is generally in conflict with quality of neutrality, because being prudent or conservative can lead to bias in the reported financial position and financial performance. (p. 64)(n). qualitative characteristics Part of the second level of the conceptual framework of accounting; the characteristics of accounting information that distinguish better (more useful) information from inferior (less useful) information for decision-making purposes. The primary qualitative characteristics are relevance and faithful representation. (p. 48). realizable (revenue) Part of the first test of the revenue recognition principle, revenues are realizable when assets received or held are readily convertible into cash or claims to cashthat is, when they are salable or interchangeable in an active market at readily determinable prices without significant additional cost. (p. 60). realized (revenue) When assets received or held are converted into cash or claims to cashthat is, when they are sold or traded in an active market at readily determinable prices without significant additional cost. (p. 60). relevance One of the qualitative characteristics of accounting information, which describes information capable of making a difference in a decision. Information with no bearing on a decision is irrelevant. To be relevant, information needs predictive or feedback value and needs to be presented on a timely basis. (p. 48). revenue recognition principle One of the basic principles of accounting, which dictates that companies recognize revenue when it is realized or realizable and when it is earnedthat is, when assets are salable or interchangeable in an active market at readily determinable prices without significant additional cost and when the company substantially accomplishes what it must do to be entitled to the benefits represented by the revenues. Generally, recognition at the time of sale provides a uniform and reasonable test. (p. 60). supplementary information Information included in the notes to financial statements, which includes details or amounts that present a different perspective from that adopted in the financial statements. It may be quantifiable information that is high in relevance but low in reliability and may include managements explanation of the financial information and its discussion of the significance of that information. (p. 62). timeliness An enhancing qualitative characteristic of accounting information, indicating that information should be available to decision-makers before it loses its capacity to influence their decisions. (p. 53). understandability An enhancing qualitative characteristic of accounting information that lets reasonably informed users see its significance. (p. 53). verifiability An enhancing qualitative characteristic of accounting information, indicating that similar results will occur when independent third parties (e.g., auditors) measure using the same methods. (p. 52).
GlossaryChapter 3
account A systematic arrangement that shows the effect of transactions and other events on a specific element (asset, liability, and so on). Companies keep a separate account for each asset, liability, revenue, and expense, and for capital (stockholders equity). (p. 88). accounting cycle Standard set of accounting procedures to record transactions and prepare financial statements. (p. 93). accounting information system A system that collects and processes transaction data and then disseminates the financial information to interested parties. Accounting information systems vary widely from one business to another, depending on the nature of the business and its transactions, the size of the company, the volume of data to be handled, and the informational demands. (p. 88). accrued expenses Expenses incurred but not yet paid or recorded at the statement date. Examples are interest, rent, taxes, and salaries. An accrued expense on the books of one company is often an accrued revenue to another company. (p. 108). accrued revenues Revenues earned but not yet received in cash or recorded at the statement date. Accrued revenues result from the passing of time (e.g., interest revenue and rent revenue) or from unbilled or uncollected services that a company performed (e.g., commissions and fees). (p. 107). adjusted trial balance A trial balance prepared from a companys ledger accounts after journalizing and posting all adjusting entries. It shows the effects of all financial events that occurred during the accounting period. (pp. 89, 111). adjusting entry Adjustments made at the end of the accounting period to ensure that a company has recorded revenues in the period in which it earns them and recognized expenses in the period in which it incurs themin other words, that it has followed the revenue recognition and expense recognition principles. Companies often prepare adjustments after the balance sheet date but date the entries as of the balance sheet date. (pp. 89, 100). balance sheet Financial statement that shows the financial condition of a company at the end of a period by reporting its assets, liabilities, and owners equity. (p. 89). book value The difference between a depreciable assets cost and its related accumulated depreciation. Book value of an asset generally differs from its market value because depreciation is a means of cost allocation, not of valuation. (p. 105). closing entries Journal entries made at the end of a companys annual accounting period to transfer the balances of temporary accounts to a permanent owners equity account (retained earnings or a capital account, depending on the companys form of organization). (pp. 89, 114). closing process Accounting process at the end of the accounting period that reduces the balance of nominal (temporary) accounts to zero in order to prepare the accounts for the next periods transactions. In the closing process, the company transfers revenue and expense account balances to Income Summary, which matches expenses and revenues. (p. 113). contra asset account An account that offsets an asset account on the balance sheet. An example is the accumulated depreciation account, which companies use in order to disclose both the original cost of an asset and the total expired cost to date. (p. 105). credit The right side of an account. Commonly abbreviated as Cr. (p. 89). debit The left side of an account. Commonly abbreviated as Dr. (p. 89). depreciation The process of allocating the cost of an asset to expense over its useful life in a rational and systematic manner. (p. 104). double-entry accounting The universally used accounting system in which a company records the dual (two-sided) effect of each transaction in appropriate accounts. If a company records every transaction with equal debits and credits, then the sum of all the debits to the accounts must equal the sum of all the credits. (p. 90). event A happening of consequence, which generally is the source or cause of changes in assets, liabilities, and equity. Events may be external or internal. (p. 88). financial statements The principal means through which a company communicates its financial information. These statements reflect the collection, tabulation, and final summarization of the accounting data. The statements most frequently provided are (1) the balance sheet, (2) the income statement, (3) the statement of cash flows, and (4) the statement of owners or stockholders equity. Note disclosures are an integral part of a companys financial statements. (p. 89).
general journal A complete record of a companys transactions or other financial events, listed chronologically and expressed in terms of debits and credits made to accounts. (p. 95). general ledger A list of all of a companys asset, liability, stockholders equity, revenue, and expense accounts. (pp. 89, 95). income statement Financial statement that measures the results of operations during a particular period and presents those results in terms of net income or net loss. (p. 89). journal The book of original entry where the company initially records transactions and selected other events. The company transfers that information from the journal to the ledger. (p. 89). journalizing The process of entering transaction data in the journal. (p. 89). ledger The book (or computer printouts) containing the accounts. A general ledger is a collection of all the asset, liability, owners (stockholders) equity, revenue, and expense accounts. A subsidiary ledger contains the details related to a given general ledger account. (p. 89). nominal accounts Revenue, expense, and dividend accounts; except for dividends, these accounts appear on the income statement. Companies close nominal accounts, also called temporary accounts, at the end of the accounting period. (p. 89). post-closing trial balance The trial balance after closing entries are made; consists only of asset, liability, and owners equity accounts (the real accounts). (pp. 89, 116). posting The process of transferring the essential facts and figures from the book of original entry (the journal) to the ledger accounts, using debits and credits made to accounts. (pp. 89, 96). prepaid expenses Assets paid for and recorded before a company uses them. Prepaid expenses expire either with the passage of time (e.g., rent and insurance) or through use and consumption (e.g., supplies). Companies typically recognize prepaid expenses by making adjusting entries to record the expenses that apply to the current accounting period and to show the unexpired costs in the asset accounts. (p. 102). real accounts Asset, liability, and equity accounts; these accounts appear on the balance sheet. Companies do not close real accounts, also called permanent accounts. (p. 89). reversing entries Journal entries, made at the beginning of the next accounting period, that are the exact opposite of the adjusting entries made in the previous period. Making reversing entries is an optional step in the accounting cycle. (p. 116). special journals Records of transactions possessing a common characteristic, such as cash receipts, sales, purchases, cash payments. Using such journals reduces bookkeeping time. (p. 96). statement of cash flows Financial statement that reports the cash provided and used by operating, investing, and financing activities during the period. (p. 89). statement of retained earnings Financial statement that reconciles the balance of the retained earnings account from the beginning to the end of the period. (p. 89). subsidiary ledger A list that contains the details related to a given general ledger account. (p. 89). T-account Basic account form, shaped like the letter T, that shows the effect of transactions on particular asset, liability, stockholders equity, revenue, and expense accounts. (p. 89). transaction An external event involving a transfer or exchange between two or more entities. (p. 88). trial balance The list of all open accounts, in the sequence in which they appear in the ledger, and their balances. Companies may prepare a trial balance at any time, though they usually do so at the end of an accounting period. The trial balance proves the mathematical equality of debits and credits after posting and also uncovers errors in journalizing and posting. (pp. 89, 100). unearned revenues Revenues received in cash and recorded as liabilities before a company earns them. Examples are rent, magazine subscriptions, and customer deposits for future service. Unearned revenues are the opposite of prepaid expenses. (p. 106). Appendix 3A: accrual basis The recognition of revenue when it is earned, and the expenses in the period incurred, without regard to the time of receipt or payment of cash. (p. 121). modified cash basis A mixture of the accrual basis and cash basis, with modifications that have substantial support, such as capitalizing and depreciating plant assets or recording inventory. (p. 123). strict cash basis Companies record only when they receive cash, and they record expenses only when they disburse cash. (p. 122). Appendix 3C: worksheet An informal device for accumulating and sorting information needed for the financial
statements. The worksheet typically provides columns for the first trial balance, adjustments, adjusted trial balance, income statement, and balance sheet. Completing the worksheet provides considerable assurance that a company properly handled all of the details related to the end-of-period accounting and statement preparation. (p. 129).
GlossaryChapter 4
accumulated other comprehensive income An entry in the stockholders equity section of the balance sheet that reports the cumulative amounts of Other Comprehensive Income. Other Comprehensive Income measures the amounts of all gains and losses in a period that bypass the income statement but affect stockholders equity. These amounts arise from such items as unrealized gains or losses on certain investments and unrealized gains and losses on certain hedging transactions. (p. 183). Appropriated Retained Earnings A retained earnings account that is restricted for a specific use, usually to comply with contractual requirements, board of directors policy, or current necessity. (p. 180). capital maintenance approach An income measurement approach in which a company determines income for the period based on the change in equity, after adjusting for capital contributions or distributions (dividends). An alternative to the transaction approach for income measurement. (p. 162) (n). changes in estimates Adjustments or changes that companies must make because financial circumstances did not turn out as expected. Companies account for changes in estimates in the period of change if they affect only that period, or in the period of change and future periods if the change affects both. They do not carry back such changes to prior years. Changes in estimate are not considered errors or extraordinary items. (p. 175). comprehensive income Income measure that includes all changes in equity during a period except those resulting from investments by owners and distributions to owners. Comprehensive income includes all revenues and gains, expenses and losses reported in net income, and all gains and losses that bypass net income but affect stockholders equity. These latter amounts arise from such items as unrealized gains or losses on certain investments and unrealized gains and losses on certain hedging transactions. (p. 182). current operating performance approach Income-reporting approach that advocates reporting only regular and recurring revenue and expense elements, but not irregular items, in income. (p. 168). discontinued operation Occurs for a company when two things happen: (1) a company eliminates the results of operations and cash flows of a component from its ongoing operations, and (2) there is no significant continuing involvement in that component after the disposal transaction. Companies report a discontinued operation (in a separate income statement category), indicating the gain or loss from disposal of a business. In addition, companies report separately from continuing operations the results of operations of a component that has been, or will be, disposed of. (p. 169). earnings management The planned timing of revenues, expenses, gains, and losses to smooth out bumps in earnings. (p. 161). earnings per share (EPS) A distilled and important income figure, calculated as net income minus preferred dividends (income available to common stockholders), divided by the weighted average of common shares outstanding. Companies must disclose earnings per share on the face of the income statement. (p. 178). extraordinary items Nonrecurring material items that differ significantly from a companys typical business activities. They are distinguished by their unusual nature and by the infrequency of their occurrence. (p. 170). income statement The financial report that measures the success of company operations for a given period of time. It is also often called the statement of income or statement of earnings. (p. 160). intraperiod tax allocation Reporting of irregular items within an accounting period on the income statement or statement of retained earnings net of tax. Such allocation relates the income tax expense of the fiscal period to the specific items that give rise to the amount of the tax provision. It helps financial statement users better understand the impact of income taxes on the various components of net income, and it discourages statement readers from using pretax measures of performance when evaluating financial results. (p. 177). irregular items Income-statement components for which the FASB has established special reporting rules. These items fall into six general categories: (1) discontinued operations, (2) extraordinary items, (3) unusual gains and losses, (4) changes in accounting principle, (5) changes in estimates, and (6) corrections of errors. (p. 169). modified all-inclusive concept Approach, adopted by the accounting profession, that dictates that companies record just about all items, including irregular ones, as part of net income, and that companies must highlight irregular items in the financial statements. (p. 169). multiple-step income statement Income statement format that separates operating transactions from
nonoperating transactions, and matches costs and expenses with related revenues. It highlights certain intermediate components of income that analysts use to compute ratios for assessing the performance of the company. (p. 164). other comprehensive income Measure of the amounts of all gains and losses in a period that bypass the income statement but affect stockholders equity. These amounts arise from such items as unrealized gains or losses on certain investments and unrealized gains and losses on certain hedging transactions. (p. 182). prior period adjustments Corrections of accounting errors made in previous accounting periods. Companies correct such errors by making proper entries in the accounts and reporting the corrections in the financial statements (as an adjustment to the beginning balance of retained earnings) in the year in which they are discovered. If a company prepares comparative financial statements, it should restate the prior statements for the effects of the error. (p. 175). quality of earnings The extent to which earnings is useful to investors and creditors in making resource allocation decisions, generally in terms of predicting future earnings and cash flows. Thus, higher-quality earnings exhibit higher levels of relevance and faithful representation. Earnings of high quality boost investors confidence in the financial statements. Earnings management negatively affects the quality of earnings when it distorts the information in a way that does not accurately predict future earnings and cash flows. (p. 161). single-step income statement Income statement format that consists of just two groupings: revenues and expenses. Expenses are deducted from revenues to arrive at net income or loss. Companies that use the single-step income statement in financial reporting typically do so because of its simplicity. (p. 163). statement of stockholders equity One of the basic financial statements, which reports the changes in each stockholders equity account and in total stockholders equity during the year. It typically shows balances at the beginning of the period, additions and deductions, and balances at the end of the period. Companies disclose changes in the separate accounts either in separate statements or in the basic financial statements or notes thereto. (p. 183). transaction approach Method of income measurement that focuses on the income-related activities revenue, expense, gain, and loss transactionsthat have occurred during the period. (p. 162).
GlossaryChapter 5
account form Presentation in a classified balance sheet that lists assets by sections on the left side and liabilities and stockholders equity by sections on the right side. (p. 225). adjunct account An account that increases either an asset, liability, or owners equity account. An example is Premium on Bonds Payable, which, when added to the Bonds Payable account, describes the total bond liability of the company. (p. 241). available-for-sale investments Debt or equity securities not classified as held-to-maturity or trading securities. Companies report available-for-sale securities at fair value, but do not report changes in fair value as part of net income until after they sell the security. Interest on available-for-sale securities is recorded when earned. Unrealized holding gains and losses on available-for-sale securities are recognized as other comprehensive income and as a separate component of stockholders equity. (p. 218). balance sheet Financial statement that shows the financial condition of a company at the end of a period by reporting its assets, liabilities, and stockholders equity (p. 214). cash debt coverage ratio Measure of solvency that indicates a companys ability to repay its liabilities from cash generated from operations (without having to liquidate productive assets). Computed as the ratio of cash provided by operating activities to total debt, as represented by average total liabilities. (p. 234). contingency Material events with an uncertain future. The uncertainty can involve a possible gain (gain contingency) or possible loss (loss contingency) that will ultimately be resolved when one or more future events occur or fail to occur. Typical gain contingencies are tax operating loss carryforwards or company litigation against another party. Typical loss contingencies relate to litigation, environmental issues, possible tax assessments, or government investigations. (p. 236). contra account An account that reduces either an asset, liability, or owners equity account. Examples include Accumulated DepreciationEquipment and Discount on Bonds Payable. Use of contra accounts enables readers of financial statements to see the original cost of the asset, liability, or owners equity account as well as the changes in the account to date. (p. 241). current assets Cash and other assets a company expects to convert into cash, sell, or consume either in one year or in the operating cycle, whichever is longer. Companies present current assets in the balance sheet in order of liquidity. (p. 217). current cash debt coverage ratio Measure of liquidity that indicates a companys ability to pay its shortterm debts. Computed as cash provided by operating activities divided by average current liabilities. (p. 233). current liabilities The obligations that a company reasonably expects to liquidate either through the use of current assets or the creation of other current liabilities. This concept includes payables resulting from the acquisition of goods and services; (2) collections received in advance for the delivery of goods or performance of services; and (3) other liabilities whose liquidation will take place within the operating cycle. (p. 222). financial flexibility The ability of a company to take effective actions to alter the amounts and timing of cash flows so it can respond to unexpected needs and opportunities. A companys liquidity and solvency affect its financial flexibility. (p. 215). financial instruments Assets consisting of cash, accounts receivable, an ownership interest, or a contractual right to receive or obligation to deliver cash or another financial instrument. (p. 238). financing activities Cash flow activities that include (1) obtaining cash from issuing debt and repaying the amounts borrowed, and (2) obtaining cash from stockholders and paying them dividends. (p. 229). free cash flow Measure of the cash remaining from operating activities after adjusting for capital expenditures and dividends paid. Some analysts prefer free cash flow to the measure of cash provided by operating activities because free cash flow takes into account the outflows needed to maintain current operations. (p. 234). held-to-maturity investments Debt securities that a company has the positive intent and ability to hold to maturity. (p. 218). intangible assets Assets that lack physical substance and that are not financial instruments. Intangible assets derive their value from the rights and privileges granted to the company using them. They are normally classified as long-term assets. Companies write off (amortize) limited-life intangible assets over their useful lives, and they periodically assess indefinite-life intangibles (including goodwill) for impairment. (p. 222).
investing activities Cash flow activities that include (1) purchasing and disposing of investments and productive long-lived assets using cash, and (2) lending money and collecting the loans. (p. 229). liquidity The amount of time that is expected for an asset to be realized or otherwise converted into cash or until a liability has to be paid. In general, the greater a companys liquidity, the lower its risk of failure. (p. 214). long-term investments Investments that companies expect to hold for many years. Examples are: (1) investments in securities, such as bonds or common stock; (2) investments in tangible fixed assets not currently used in operations, such as land held for speculation; (3) investments set aside in special funds, such as a pension fund; and (4) investments in nonconsolidated subsidiaries. Companies usually present long-term investments on the balance sheet just below current assets. (p. 220). long-term liabilities Obligations that a company expects to pay at some date beyond the normal operating cycle. Examples are bonds payable, notes payable, some deferred income tax amounts, lease obligations, and pension obligations. Also referred to as long-term debt. Companies provide a great deal of supplementary disclosure for long-term liabilities because they often are subject to covenants and restrictions for the protection of lenders. (p. 224). operating activities Cash flow activities include the cash effects of transactions that create revenues and expenses, and thus enter into the determination of net income. (p. 228). owners (stockholders) equity The ownership claim on a companys total assets. The owners equity section of the corporate balance sheet consists of capital stock, additional paid-in capital, and retained earnings. The ownership accounts (stockholders equity) in a corporation differ considerably from ownership accounts in a partnership or proprietorship. Partners show separately their permanent capital accounts and the balance in their temporary accounts (drawing accounts). Proprietors ordinarily use a single capital account that handles all of the owners equity transactions. (p. 225). property, plant, and equipment Assets of a durable nature used in the regular operations of the business. These assets consist of physical property (such as land, buildings, machinery) and wasting resources (timberland, minerals). With the exception of land, a company either depreciates (e.g., buildings) or depletes (e.g., oil reserves) these assets. (p. 221). report form Presentation in a classified balance sheet that lists liabilities and stockholders equity directly below assets on the same page. (p. 226). reserve An appropriation of retained earnings. Also called appropriated earnings. (p. 242). solvency The ability of a company to pay its debts as they mature. A company with a high level of longterm debt relative to assets has lower solvency than a similar company with a low level of long-term debt. (p. 215). statement of cash flows A basic financial statement that provides information about cash receipts, cash payments, and the net change in cash resulting from the operating, investing, and financing activities of a company during the period, in a format that reconciles the beginning and ending cash balances. (p. 227). trading investments Debt and equity securities bought and held primarily for sale in the near term to generate income on short-term price differences. (p. 218). working capital The excess of total current assets over total current liabilities; represents the net amount of a companys relatively liquid resources. Also called net working capital. (p. 223). Appendix 5A: activity ratios Measures of how effectively a company is using its assets. Common activity ratios are receivables turnover, inventory turnover, and asset turnover. (p. 244). coverage ratios Measures of the degree of protection for long-term creditors and investors. Common coverage ratios are debt to total assets, times interest earned, the cash debt coverage ratio, and book value per share. (p. 244). liquidity ratios Measures of a companys short-run ability to pay its maturing obligations. Common liquidity ratios are the current ratio, the quick or acid-test ratio, and the current cash debt coverage ratio. (p. 244). profitability ratios Measures of the degree of success or failure of a given company or division for a given period of time. Common profitability ratios are profit margin on sales, rate of return on assets, rate of return on common stock equity, earnings per share, the price-earnings ratio, and the payout ratio. (p. 244). ratio analysis An evaluation of the relationship among selected financial statement data, expressed in terms of either a percentage, a rate, or a simple proportion. (p. 244).
Chapter 1 Financial Accounting and Accounting Standards Results
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0% (0 out of 26 correct)
Responses to questions are indicated by the
symbol.
1. The first step taken in the establishment of a typical FASB statement is: A. the board conducts research and analysis and a discussion memorandum is issued. B. a public hearing on the proposed standard is held. C. the board evaluates the research and public Feedback and issues an exposure draft. D. topics are identified and placed on the board's agenda.
The first step taken in establishing financial accounting standards is a topic is identified and placed on the board's agenda.
2. The most authoritative source of GAAP among the following is FASB: A. Emerging Issues Task Force Statements. B. Implementation Guides. C. Interpretations. D. Technical Bulletins.
FASB Interpretations (and standards) are the most authoritative source of GAAP.
3. International Financial Reporting Standards (IFRS) are issued by the: A. FASB. B. IASB. C. IASF. D. SEC.
The International Accounting Standards Board (IASB) issues International Financial Reporting Standards (IFRS).
4. All of the following are true regarding IFRS except: A. IFRS includes standards referred to as International Auditing Standards (IAS). B. The adoption of IFRS by U.S. Companies would make it easier to compare them with foreign companies. C. IFRS is more principle-based than U.S. GAAP.
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D. IFRS are developed by the IASB.
All of the options are true except that IFRS includes standard referred to as International Financial Reporting Standards, rather than International Auditing Standards.
5. Corporations whose securities are listed on a U.S. stock exchange are required to file audited financial statements with the Financial Accounting Standards Board. A. True B. False
Public corporations are required to file audited statements with the Securities Exchange Commission.
6. The Norwalk Agreement between the FASB and the IASB address the issue of ethics in financial reporting A. True B. False
The Norwalk Agreement address the issue of convergence of U.S. GAAP and IFRS.
7. The Codification eliminates the hierarchy of GAAP so that all documents included are considered authoritative. A. True B. False
The Codification creates one level of GAAP which is considered authoritative.
8. Financial Accounting Concepts are a major type of pronouncement issued by the FASB. A. True B. False
Financial Accounting Concepts are one of the three major types of pronouncements issued by the FASB.
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9. The passage of a new FASB Standards Statement requires the support of three of five Board members. A. True B. False
FASB Standards passage requires support of three of five Board members.
10. Financial reports generally focus on soft assets such as Apple's brand image or Wal-Mart's supply chain management system. A. True B. False
Financial reports focus on hard assets such as inventory and plant assets.
11. The AICPA's Practice Bulletins provide the Accounting Standards Executive Committee's views on narrow financial reporting issues that have not been addressed by the FASB. A. True B. False
Practice Bulletins focus on narrow financial reporting issues that have not been addressed by the FASB
12. Section 404 of the Sarbanes Oxley-Act requires public companies to attest to the effectiveness of their internal controls. A. True B. False
Section 404 requires public companies to document and test the effectiveness of their internal controls systems for financial reporting.
13. Foreign companies that list on U.S. exchanges are required to use U.S. GAAP. A. True B. False
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Foreign companies that list on U.S. exchanges can use IFRS.
14. All listed companies in the European Union use IFRS. A. True B. False
Over 100 countries including those in the European Union use IFRS.
15. IFRS is more rule-based in its approach to standards than U.S. GAAP. A. True B. False
IFRS is more principle-based in its approach to standards than is U.S. GAAP.
16. Which of the following generally provides a better indication of an enterprise's present and continuing ability to generate favorable cash flows? A. Cash basis accounting. B. Accrual basis accounting. C. Managerial basis accounting. D. Financial basis accounting.
Accrual basis accounting better indicates present and continuing favorable cash flows for a company.
17. Which group selects members of the FASB? A. FAF. B. SEC. C. AICPA. D. FASAC.
The Financial Accounting Foundation (FAF) is the group that selects members of the FASB.
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18. Which of the following is not a significant difference between the FASB and its predecessor, the APB? A. Greater autonomy. B. Larger membership. C. Increased independence. D. Broader representation.
Board membership decreased from 18 to 5 members.
19. Which of the following organizations is not part of the current standard-setting structure? A. Financial Accounting Foundation. B. Financial Accounting Standards Board. C. Financial Accounting Council. D. Financial Accounting Standards Advisory Council.
All of the above, except the Financial Accounting Council, are part of the current standard-setting structure.
20. Which of the following documents is not issued during the due process system that results in a new pronouncement? A. Staff positions. B. FASB Standard. C. Exposure draft. D. Discussion memorandum.
Staff positions are issued without going through the due process system.
21. The Financial Accounting Standards Board is composed of how many board members? A. 7. B. 10. C. 5. D. 18.
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The FASB is composed of 5 members, replacing the 18 member board of the APB.
22. The organization whose purpose is to reach consensus on how to account for new and unusual financial transactions that have potential for creating differing financial reporting practices is the: A. FASB. B. FASAC. C. EITF. D. AICPA.
The Emerging Issues Task Force has this responsibility.
23. All of the following are true regarding the FASB Codification except: A. the goal of the Codification was to provide one place where all authoritative literature about financial statement preparation could be found. B. the purpose of the Codification is to create new GAAP. C. the Codification was created to simplify user access. D. the Codification changes the way GAAP is documented, presented, and updated.
The Codification's purpose is to integrate and synthesize existing GAAPnot to create new GAAP.
24. International Financial Reporting Standards (IFRSs) are issued by the: A. FASB B. IASB C. SEC D. EU
The International Accounting Standards Board issues IFRS.
25. The Sarbanes Oxley Act does all of the following except: A. requires codes of ethics for senior financial officers.
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B. transfers the final authority for GAAP to the PCAOB. C. strengthens independence rules for auditors. D. requires independence and financial expertise for members of the audit committee.
The Sarbanes Oxley Act created the PCAOB, an oversight board with enforcement authority and the responsibility for establishing auditing, quality control and independence standards.
26. All of the following statements are true regarding convergence of U.S. GAAP with IFRS except: A. Foreign companies that trade shares in U.S. markets are required to reconcile their accounting with U.S. GAAP under these convergence efforts. B. The IASB has looked to the United States to determine the structure it should follow in establishing IFRS. C. The standard-setting structure for IFRS is very similar to the standard-setting structure in the United States. D. IFRS tends to be less stringent in its disclosure requirements than U.S. GAAP.
Regulators have recently eliminated the need for foreign companies that trade shares in U.S. markets to reconcile their accounting with U.S. GAAP.
Retake Test
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Chapter 2 Conceptual Framework for Financial Accounting Results
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symbol.
1. Providing information that is of sufficient importance to influence the judgment: and decisions of an informed user is required by the A. full disclosure principle. B. historical cost principle. C. expense recognition principle. D. revenue recognition principle.
The full disclosure principle requires providing information that will influence the judgment and decisions of informed users.
2. The four basic assumptions underlying the financial accounting structure include all of the following except: A. monetary unit assumption. B. going concern assumption. C. economic entity assumption. D. historical cost assumption.
Historical cost is a measurement principle, not a basic assumption.
3. Companies and their auditors have adopted a general rule of thumb that anything under 5% of _______ is considered not material. A. assets. B. liabilities. C. net income. D. sales.
Anything under 5% of net income is generally considered not material.
4. Which of the following statements about the fair value principle is not true? A. Fair value is a market-based measure. B. Fair value is generally more relevant than historical cost.
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C. Measurement based on fair value can increase subjectivity into financial reporting. D. GAAP requires the use of fair value for financial assets and financial liabilites.
GAAP gives companies the option of using fair value for financial assets and financial liabilities.
5. All of the following statements are false regarding the IASB and FASB convergence efforts except: A. the FASB framework extensively discusses and assumes that reporting entities are going concerns. B. the IASB and FASB have not been able to agree on qualitative characteristics, so that part of the project was scrapped. C. the FASB framework does not identify accrual accounting as an assumption. D. there is a need to change many aspects of existing frameworks.
While the FASB framework discusses accrual accounting extensively, it does not identify it as an assumption.
6. The historical cost principle applies even when a firm is not a going concern. A. True B. False
In certain circumstances revenue may be recognized during production, at the end of production or after the sale once cash is received.
7. The full disclosure principle requires that all information that is of sufficient importance to influence the judgment and decisions of informed users be disclosed in the main body of the financial statements and in the notes to the financial statements. A. True B. False
Disclosure may also be accomplished through supplementary information.
8. The pervasive criterion of accounting information is decision usefulness.
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A. True B. False
All three of the objectives of financial reporting stress the importance of useful information.
9. Information that has been measured and reported in a similar manner for different enterprises is considered comparable. A. True B. False
Comparability is between firms.
10. For information to be relevant, it needs to have predictive or feedback value. A. True B. False
For information to be relevant, it needs to have predictive value, feedback value, and be timely.
11. The FASB sometimes issues standards that have undesirable economic effects on an industry or company. A. True B. False
Because of the neutrality ingredient of the fundamental quality of faithful representation, the FASB does not favor one set of interested parties over another.
12. The periodicity assumption specifies that the appropriate time period for financial reporting is the calendar year. A. True B. False
The periodicity assumption suggests that the economic life of a business can be divided
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into artificial time periods such as a month, quarter or year.
13. Certain financial instruments are reported at fair value rather than historical cost. A. True B. False
Fair value information is useful for financial instrument such as derivatives.
14. Costs are classified as period costs when a company cannot establish a direct relationship between the cost and revenues. A. True B. False
Period costs, such as administrative salaries, are expensed in the period when incurred because there is no direct relationship between the cost and revenues.
15. The objective of the joint project of the IASB and the FASB is to develop a conceptual framework to replace the going concern concept. A. True B. False
The objective of the convergence project is to develop a common conceptual framework based on existing conceptual frameworks that underlie U.S. GAAP and IFRS.
16. The conceptual framework contains how many Statements of Financial Accounting Concepts that related to financial reporting for business enterprises? A. 7 B. 6 C. 5 D. 4
The framework consists of 7 Statements of Financial Accounting Concepts. SFAC 1 3 and 5 8. SFAC 4 deals with non-business enterprises.
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17. The conceptual framework for financial reporting consists of how many levels? A. 1 B. 2 C. 3 D. 4
There are 3 levels, the Why, the Bridge between levels 1 & 3, and the How.
18. Which level of the conceptual framework is devoted to recognition and measurement concepts? A. First. B. Second. C. Third. D. All three levels.
The third level which consists of assumptions, principles, and constraints.
19. The fundamental qualities of accounting information are: A. comparability and verifiability. B. relevance and consistency. C. comparability and materiality. D. relevance and faithful representation.
The fundamental qualities are relevance and faithful representation.
20. All of the following are ingredients of reliability, except: A. confirmatory value. B. predictive value. C. faithful representation. D. materiality.
Faithful representation is a fundamental quality, not an ingredient of relevance.
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21. Which of the following elements of financial statements is the result of transactions, events, or circumstances that affect an enterprise during a period of time? A. Assets. B. Liabilities. C. Equity. D. Comprehensive income.
All of the options, other than comprehensive income, are for a moment in time.
22. The assumption that allows the merging of a parent company and its subsidiaries for financial reporting purposes is the: A. going concern assumption. B. economic entity assumption. C. monetary unit assumption. D. periodicity assumption.
A parent and its subsidiaries are separate legal entities, but a single economic entity.
23. Which assumption makes the current noncurrent classification of assets and liabilities on the balance sheet useful? A. Going concern assumption. B. Economic entity assumption. C. Monetary unit assumption. D. Periodicity assumption.
In liquidation the distinction between current and noncurrent would not be useful.
24. Which of the following is an important advantage of using cost over other possible valuations? A. Verifiability. B. Relevance. C. Comparable.
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D. All of the above.
Historical cost is reliable due to its being inherently objective and verifiable.
25. Which of the following is a constraint recognized by the Conceptual Framework? A. Materiality. B. Cost. C. Periodicity. D. Industry practices.
The Conceptual Framework recognized the cost constraint.
26. All of the following statements are true regarding the convergence project by the FASB and IASB except: A. the converged framework should be a single document, unlike the two conceptual frameworks that presently exist. B. the existing conceptual frameworks underlying U.S. GAAP and IFRS are very similar. C. the IASB framework makes three assumptions. D. the FASB framework discusses accrual accounting exclusively but does not identify it as an assumption.
The IASB framework makes two assumptions accrual basis and going concern.
Retake Test
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Chapter 3 The Accounting Information System Results
Page 1 of 7
symbol.
1. In the closing process all of the revenue and expense account balances are transferred to the: A. Capital account. B. Income Summary account. C. Retained Earnings account. D. Dividends account.
All revenue and expense account balances are transferred to the Income Summary account.
2. All of the following accounts are used with a perpetual inventory system except: A. Cost of Goods Sold. B. Inventory. C. Purchases. D. Sales Revenue.
No Purchases account is used because the purchases are debited directly to the Inventory account.
3. The post-closing trial balance consists only of: A. asset and liability accounts. B. nominal accounts. C. revenue and expense accounts. D. real accounts.
Only real accounts are included on the post-closing trial balance.
4. If the entry to close Income Summary to Retained Earnings includes a credit to Income Summary: A. the company has incurred a net loss. B. Retained Earnings will be increased by the current period's net income. C. Dividends paid exceed the net income earned for the period.
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D. Revenues exceed expenses.
If the Income Summary has a debit balance, the company has incurred a net loss because expenses exceeded revenue.
5. Which one of the following accounts would have an amount listed in the credit column of a post-closing trial balance? A. Merchandise Inventory. B. Purchases. C. Accounts Payable. D. Sales Revenue.
The balance in Accounts Payable would be listed in the credit column of a post-closing trial balance.
6. All of the following are points made about accounting information systems and their relationship to the convergence efforts by the IASB and the FASB except: A. the cost of good information and better internal controls is a general held reason for why U.S. security markets more competitive. B. while there is a need to work toward international convergence of accounting standards, there has also been a movement to improve international auditing standards. C. commentators argue that SOX is the cause of the relative decline of U.S. IPOs. D. commentators argue that the growth in non-U.S. markets is a natural consequence of general globalization of capital flows.
The higher cost of good information and better internal controls is part of the debate about why the U.S. security markets are less competitive.
7. Nominal accounts are periodically closed. A. True B. False
Nominal (also called temporary) accounts are closed at the end of each accounting period.
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8. Dividends are increased on the debit side. A. True B. False
Dividends is a nominal contra stockholders' equity account; therefore it has a debit balance and is increased with debits.
9. Transactions are initially recorded in the general ledger. A. True B. False
Transactions are initially recorded in the general journal.
10. When revenues are collected in advance of being earned, it is normally called an accrued revenue. A. True B. False
A revenue collected in advance of being earned is called an unearned revenue.
11. In a periodic inventory system, purchases and sales are recorded directly in the inventory account as the purchase and sales occur. A. True B. False
Purchases and sales are recorded directly to the inventory account in a perpetual inventory system.
12. Revenue, equity and liability accounts have normal credit balances. A. True B. False
Revenue, equity and liability accounts all are increased by credits and have normal credit
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balances.
13. The journal entry to accrue interest expense includes a debit to an expense account and a credit to an asset account. A. True B. False
The journal entry to accrue interest expense includes a debit to an expense account and a credit to a liability account.
14. The book value of an asset is cost less salvage value. A. True B. False
The book value of an asset is cost less accumulated depreciation.
15. Depreciation and amortization allocate the cost of long-term assets to the periods which benefit from their use. A. True B. False
Tangible assets are depreciated and intangible assets are amortized so that that the cost of the assets is allocated over their useful lives in a systematic and rational manner.
16. The revenue recognition principle requires that bad debts be estimated and expensed in the period of the sale. A. True B. False
The expense recognition principle requires that bad debts be estimated and expensed in the period of the sale.
17. Since non-U.S. markets are not affected by the Sarbanes Oxley Act (SOX), internal controls will not be discussed as part of the convergence efforts of the FASB and IASB.
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A. True B. False
While enhanced internal control standards under SOX apply only to large public companies listed on U.S. exchanges, there is continuing debate over whether foreign issuers should have to comply with this extra layer of regulation.
18. In a double entry system every transaction affects: A. only one account. B. at least two accounts. C. three or more accounts. D. only two accounts.
In order to keep the basic accounting equation in balance, every transaction will affect at least two accounts.
19. In a proprietorship, the Capital account takes the place of all of the following corporation accounts except: A. Common Stock. B. Additional Paid in Capital. C. Retained Earnings. D. Dividends.
The Drawing account takes the place of the Dividends account.
20. Which of the following is a real account? A. Interest Payable. B. Dividends. C. Interest Revenue. D. Interest Expense.
Interest Payable is a real (permanent) account. All of the others are nominal (temporary) accounts.
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21. Which of the following steps in the accounting cycle is not optional? A. Work sheet. B. Reversing entries. C. Adjusted trial balance. D. Post closing trial balance.
Only the adjusted trial balance is required.
22. All of the following statements about contra asset accounts are true except: A. Contra asset accounts have normal credit balances. B. Contra asset accounts are permanent accounts. C. Contra asset accounts are not reported in the financial statements. D. Contra asset accounts are increased with credits.
Contra asset accounts are reported on the balance sheet as deductions from the associated asset account.
23. Which of the following errors would cause a trial balance to not balance? A. Not journalizing a transaction. B. Not posting a journal entry. C. Posting a journal entry twice. D. Recording a transaction with several errors that are not offsetting.
Any time errors are not offsetting debits and credits will not balance.
24. Adjusting entries can be classified as either: A. accruals or reversals B. prepayments or accruals. C. real or nominal. D. internal or external.
The two types of adjustments are prepayments and accruals.
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25. The difference between the cost of a depreciable asset and its related contra account, Accumulated Depreciation is referred to as the asset's: A. book value. B. fair value. C. market value. D. real value.
The undepreciated cost of an asset is its book value.
26. Unearned revenues are classified as: A. assets. B. liabilities. C. revenues. D. stockholders' equity.
Unearned revenues are liabilities because the firm owes the customer that amount of goods and services.
27. Which of the following accounts are not used with a perpetual inventory system? A. Merchandise inventory. B. Cost of goods sold. C. Purchases. D. Sales Revenue.
The Purchases account is part of a periodic inventory system, not the perpetual inventory system.
Retake Test
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Chapter 4 Income Statement and Related Information Results
Page 1 of 7
symbol.
1. Earnings per share is computed as net income: A. divided by the weighted average of common shares outstanding. B. minus preferred dividends divided by the weighted average of common shares outstanding. C. divided by the ending common shares outstanding. D. minus preferred dividends divided by the ending common shares outstanding.
Net income minus preferred dividends is divided by the weighted average of common shares outstanding to compute earnings per share.
2. Earnings per share are reported for: A. discontinued operations. B. extraordinary items. C. unusual gains/losses. D. discontinued operations and extraordinary items, but not unusual gains/losses.
Earnings per share is reported for discontinued operations and extraordinary items but not for unusual gains/losses.
3. Prior period adjustments are reported as: A. an extraordinary item in the income statement. B. an addition to (or deduction from) net income in the income statement. C. an addition to (or a deduction from) the beginning balance of retained earnings. D. an addition to (or deduction from) the ending balance of retained earnings.
Prior period adjustments are added to (or deducted from) the beginning retained earnings balance.
4. Gains and losses that bypass net income but affect stockholders' equity are referred to as: A. comprehensive income. B. other comprehensive income.
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C. prior period income. D. unusual gains and losses.
Other comprehensive income includes gains and losses that bypass net income.
5. The FASB decided that the components of other comprehensive income must be displayed: A. in a second separate income statement. B. in a combined statement of comprehensive income. C. as a part of the statement of stockholders' equity. D. Any of these options is permissible.
The components of other comprehensive income may be displayed using any of these options.
6. U.S. GAAP allows all of the following statement formats to be used for reporting comprehensive income except: A. Statement of Recognized Income and Expense B. Single Income Statement C. Combined Income Statement of Comprehensive Income D. Statement of Stockholders' Equity
The Statement of Recognized Income and Expense is allowed under IFRS, but not U.S. GAAP.
7. Income measurement is based on the transaction approach. A. True B. False
Net income results from revenue, expense, gain and loss transactions.
8. The single-step income statement differentiates between operating and nonoperating activities. A. True
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B. False
The single-step makes no distinction between operating and nonoperating items and only contains two groupings: revenues and expenses.
9. Irregular items, such as extraordinary items, should be reported separately following income from continuing operations. A. True B. False
Income from continuing operations should be separated from irregular items to provide statement users to differentiate between what normal and recurring and what is not.
10. Extraordinary items must be both unusual in nature and infrequent in occurrence. A. True B. False
Both criteria must be met in order for an item to be considered extraordinary.
11. Earnings per share (EPS) is calculated using the weighted average number of shares of both common and preferred stock outstanding. A. True B. False
EPS is only calculated using the weighted average number of shares of common stock outstanding.
12. Typically, companies that manage earnings increase current year profits at the expense of future profits. A. True B. False
Earnings management is the planned timing of revenues, expenses, gains, and losses and is usually used to boost current period profits by accelerating revenue or gain recognition or
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delaying expense or loss recognition.
13. A company who manages earnings may establish a cookie jar reserve by increasing current earnings in order to decrease future earnings. A. True B. False
A company who manages earnings may establish a cookie jar reserve by decreasing current earnings in order to increase future earnings.
14. Material gains or losses resulting from the disposition of a component of the business are reported in Discontinued Operations. A. True B. False
The Discontinued Operations section on the income statement includes material gains or losses resulting from the disposition of a component of the business.
15. Changes in estimates result in restatement of prior period's financial statements and an adjustment to the beginning balance of retained earnings. A. True B. False
Changes in estimates effect the current and future periods.
16. Losses as a result of a strike are reported as an extraordinary item. A. True B. False
Effects of a strike, including those against competitors and major suppliers are not extraordinary items.
17. As in U.S. GAAP, the statement of income is a required statement for IFRS.
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A. True B. False
Both IFRS and U.S. GAAP require a statement of income.
18. The limitations of the income statement include: A. items that cannot be measured reliably are not reported. B. income numbers that are affected by the accounting method used. C. income measurement involves judgment. D. All of the above.
All of the options are limitations of the income statement.
19. Which of the following occur from peripheral or incidental transactions? A. Sales revenue. B. Cost of goods sold. C. Gain on the sale of equipment. D. Operating expenses.
Gains and losses result from peripheral or incidental transactions.
20. Which of the following would be reported as other comprehensive income? A. Net income. B. Income before income taxes. C. Income from operations. D. Gross profit.
Income from operations is the result of normal recurring operations; irregular activities are disclosed after this measure of regular profitability.
21. Which of the following is not included in the operating section of a multiple-step income statement?
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A. Cost of goods sold. B. Income tax expense. C. Administrative expenses. D. Sales.
Income tax expense is disclosed in a separate section just above net income.
22. Which of the following is not considered an irregular item on the income statement? A. Income tax expense. B. Extraordinary gains. C. Discontinued operations. D. Extraordinary losses.
Income tax expense is a regular item on the income statement.
23. Which of the following items are not reported net of their applicable taxes? A. Extraordinary items. B. Discontinued items. C. Changes in accounting principle. D. Unusual gains and losses.
All of the options except unusual gains and losses are reported net of their tax effects.
24. Which of the following is an extraordinary loss? A. Restructuring charges. B. Losses from inventory obsolescence. C. Impairment losses on intangible assets. D. Flood damage losses to property where flooding is rare.
The FASB accords extraordinary item treatment to the loss from flood damages, if flood damage in the locality is rare.
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25. Which of the following is not accounted for as a change in estimate? A. a change in the estimated useful life and salvage value of equipment. B. a change from estimating bad debts expense using the percentage of receivables method to the percent of sales method. C. a change from estimating bad debts expense as 3% of credit sales to estimating bad debts expense as 5% of credit sales. D. a change from the FIFO inventory cost flow assumption to the weighted-average cost flow assumption.
A change from the FIFO inventory cost flow assumption to the weighted-average cost flow assumption is accounted for as a change in accounting principle.
26. Relating income taxes to specific items on the income statement to provide more informative disclosure to statement users is called: A. interperiod tax allocation. B. introperiod tax allocation. C. intraperiod tax allocation. D. None of the above.
Intraperiod tax allocation means allocating taxes to the specific items that caused the tax.
Retake Test
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Chapter 5 Balance Sheet and Statement of Cash Flows Results
Page 1 of 8
symbol.
1. If additional explanations cannot be conveniently shown as parenthetical explanations, the information should be disclosed by: A. cross reference. B. notes. C. supporting schedules. D. a contra account.
Notes are used when additional explanations cannot be conveniently shown as parenthetical explanations.
2. The primary purpose of a statement of cash flows is to report the: A. cash effects of operations during a period. B. net increase or decrease in cash during the period. C. investing and financing transactions. D. relevant information about the cash receipts and cash payments during a period.
The primary purpose of a statement of cash flows is to provide relevant information about the cash receipts and cash payments during a period.
3. Activities that involve the cash effects of transactions entering into the determination of net income are classified as: A. operating activities. B. investing activities. C. financing activities. D. noncash activities.
Operating activities involve the cash effects of transactions that enter into the determination of net income.
4. The last step in preparing the statement of cash flows is to: A. determine the cash provided by operations.
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B. determine the cash provided by or used in investing and financing activities. C. determine the change in cash during the period. D. reconcile the change in cash with the beginning and the ending cash balances.
Reconciling the change in cash with the beginning and ending cash balances is the last step in preparing the statement.
5. The cash debt coverage ratio is computed by dividing net cash provided by operating activities by average A. current liabilities. B. total assets. C. total liabilities. D. total long-term liabilities.
The cash debt coverage ratio is computed by dividing net cash provided by operating activities by average total liabilities.
6. Free cash flow is calculated as net cash provided by operating activities less: A. capital expenditures. B. capital expenditures and dividends. C. capital expenditures and interest. D. dividends.
Net cash provided by operating activities less capital expenditures and dividends is called free cash flow.
7. Similarities between IFRS and U.S. GAAP requirements for balance sheet presentation include all of the following except: A. both require disclosure of significant accounting policies. B. both require that changes to the valuation reserve be disclosed in the notes to the financial statements. C. both generally require the use of the current/ non-current classification for both assets and liabilities. D. both require the preparation of financial statements annually.
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Under IFRS, revaluations are recorded and reported as part of stockholders' equity.
8. The balance sheet is sometimes referred to as the Statement of Financial Position. A. True B. False
A balance sheet reports on the financial position of a business enterprise.
9. Solvency refers to the amount of time that is expected to elapse until a liability has to be paid. A. True B. False
Solvency refers to the ability to pay debts as they mature.
10. Current assets are presented in the balance sheet in their order of liquidity. A. True B. False
Current assets are presented in the order that they will be converted to cash or used up, which is their order of liquidity.
11. The financing section is the first section of the statement of cash flows. A. True B. False
The operating section is the first section of the statement of cash flows.
12. The current cash debt coverage ratio is equal to net cash provided by operating activities average total liabilities. A. True B. False
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It is net cash provided by operating activities average current liabilities.
13. Indicators of strong financial flexibility include a low debt coverage ratio and negative free cash flow. A. True B. False
A lower debt coverage ratio and negative free cash flow are indicators of poor financial flexibility.
14. Companies rarely use estimates in valuing items on the balance sheet. A. True B. False
Companies use judgments and estimates to determine many of the items reported on the balance sheet.
15. A liability that is payable within the next year is sometimes included in long-term debt. A. True B. False
A liability that is payable within the next year is sometimes included in long-term debt if the company expects to refinance the debt through another long-term issue or to retire the debt out of non-current assets.
16. The excess of total assets over total liabilities is referred to a net working capital. A. True B. False
Net working capital is the excess of total current assets over total current liabilities.
17. Investing activities on the statement of cash flows include the purchase of debt and equity
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securities. A. True B. False
The purchase of debt and equity securities is reported as an investing activity on the statement of cash flows.
18. The use of the term reserve is discouraged in both U.S. GAAP and IFRS. A. True B. False
While the use of the term reserve is discouraged in U.S. GAAP, there is no such prohibition in IFRS.
19. A balance sheet is useful for analyzing all of the following except: A. financial flexibility. B. liquidity. C. solvency. D. profitability.
Profitability is determined primarily by analyzing information from the income statement.
20. Assets can be divided into how many subclassifications? A. 5 B. 4 C. 3 D. 2
There are 5 subclassifications: current, long-term investments, PP & E, intangibles, and other.
21. Which of the following is not one of the portfolio groupings for investments in debt and equity securities?
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A. Available-for-sale. B. Trading. C. Investments. D. Held to maturity.
Investments is a subcategory of assets, not a type of portfolio.
22. Which of the following would be reported in the investments section of the balance sheet? A. Trading securities. B. Land held for future development. C. Equipment held for sale. D. Patent.
Land held for future development is classified as an investment.
23. Which of the following would be reported as a long-term asset at December 31, 2012? A. Held to maturity securities maturing in 2015. B. Equipment used in the manufacturing process. C. Land held for speculative purposes. D. Building held for sale.
Equipment used in the manufacturing process would be classified as a long-term asset.
24. Which of the following is not an intangible asset? A. Patents. B. Wasting resources. C. Goodwill. D. Franchises.
Wasting resources are a type of property, plant & equipment asset.
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25. How many different ways may pertinent information be disclosed in the financial statements? A. 4 B. 3 C. 2 D. 1
There are 4: parenthetical explanations, notes, cross-references and contra items, and supporting schedules.
26. Payment of interest expense would come under which activity on the statement of cash flows? A. Financing. B. Operating. C. Investing. D. None of the above.
Operating activities involve the cash effects of transactions that enter into the determination of net income including interest expense.
27. Payment of a cash dividend would be reported as a cash outflow in which of the following sections: A. operating activities. B. financing activities. C. investing activities. D. stock activities.
Cash dividends are an outflow under the financing activities section.
28. Which of the following would be added back to net income in the operating activities section of the statement of cash flows? A. Payment of a cash dividend. B. Increase in inventory. C. Increase in accounts payable.
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D. Gain on sale of equipment.
Increases in current liabilities are positive adjustments to net income in the operating activities section of the statement of cash flows.
Retake Test
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Unit2Chapter3SelfTestQuestions 1. Factorsthatshapeanaccountinginformationsystemincludethe A.Natureofthebusiness. B.Sizeofthefirm. C.Volumeofdatatobehandled. D.Allofthese. Correct!Thenatureofthebusiness,thesizeofthefirm,andthevolumeofdatatobehandledareallfactors thatshapetheaccountinginformationsystem. 2. Thedoubleentryaccountingsystemmeans C.Thedualeffectofeachtransactionisrecordedwithadebitandacredit. Thedoubleentryaccountingsystemmeansthedualeffectofeachtransactionisrecordedwithadebitand acredit. 3. Whichofthefollowingisarecordableeventoritem? D.Purchaseofsupplies Correct!Thepurchaseofsuppliesisarecordableevent. 4. Atrialbalance A.Provesthatdebitsandcreditsareequalintheledger. B.Listsaccountsandtheirbalances. C.Doesnotprovethatacompanyrecordedalltransactions. D.Allofthese.
5. Howdotheprepaidexpensesofrentandsuppliesexpire? A.Rent:withthepassageoftime;supplies:throughuseandconsumption Correct!Rentexpireswiththepassageoftimewhilesuppliesexpirethroughusageandconsumption. 6. Thefinancialstatementsarepreparedfromthe B.Adjustedtrialbalance. Correct!Thefinancialstatementsarepreparedfromtheadjustedtrialbalance.
7. Whichtypeofaccountisalwaysdebitedduringtheclosingprocess? C.Revenue. SincetheRevenueaccounthasanormalbalanceofacredit,itisdebitedintheclosingprocess. 8. Anaccruedexpenseis B.Anexpensethathasbeenincurredbutforwhichpaymenthasnotyetbeenmade. Correct!Anaccruedexpenseisanexpensethathasbeenincurredbutforwhichpaymenthasnotyetbeen made. 9. Whichofthefollowingisnotanominalaccount? D.Equity Dividends,Revenues,andExpensesareallnominalaccounts.Equityaccountsarerealaccounts. 10. Whenacorporationpaysanotepayableandinterest, C.TheaccountsNotesPayableandInterestExpensewillbedebited. 11. Whichofthefollowingisnotaninternalevent? C.Dividenddeclarationandsubsequentpayment Sincedividendsarepaidtoshareholders,dividenddeclarationsandpaymentsareexternalevents. 12. Atrialbalancemayprovethatdebitsandcreditsareequal,but D.Allofthese. Correct!Atrialbalanceprovestheequalityofdebitsandcreditsineachofthesesituations. 13. Adjustmentsareoftenprepared A.Afterthebalancesheetdate,butdatedasofthebalancesheetdate. Adjustmentsareoftenpreparedafterthebalancesheetdatebutaredatedasofthebalancesheetdate. 14. Thepropersequenceoffinancialstatementpreparationis: B.TheIncomeStatement,theRetainedEarningsStatement,theBalanceSheet,andthentheStatement ofCashFlows.
Correct!ThepropersequenceoffinancialstatementpreparationistheIncomeStatement,theRetained EarningsStatement,theBalanceSheet,andthentheStatementofCashFlows. 15. R.GordonCorporationhadrevenuesof$2,000,000,expensesof$1,700,000,anddividendsof$130,000. WhenIncomeSummaryisclosedtoRetainedEarnings,theamountofthedebitorcredittoRetained Earningsisa C.Creditof$300,000. Correct!SincethecredittoRetainedEarningsisequaltoRevenueslessExpenses,thecreditamountis $300,000.DividendsareclosedtoRetainedEarningsinaseparateentry. 16. Ifthebalancesinbothaccountsreceivableandaccountspayableincreaseduringtheyear C.Theincreaseintheaccountsreceivablebalancewouldresultinadecreaseincashfortheperiod. Ifthebalancesinbothaccountsreceivableandaccountspayablehaveincreasedduringtheyearthe increaseintheaccountsreceivablebalancewouldresultinadecreaseincashfortheperiodwhilethe increaseintheaccountspayablebalancewouldresultinanincreaseincashfortheperiod. 17. Thefinancialstatementthatshowsthefinancialconditionoftheenterpriseattheendofaperiodisthe: C.Balancesheet. Thebalancesheetshowsanenterprise'sfinancialconditionattheendofaperiod. 18. Allofthefollowingaccountsareincreasedonthecreditsideexcept: B.SalariesExpense. TheSuppliesExpenseaccountisincreasedonthedebitside. 19. Whichofthefollowingarereportedinthestockholders'equitysectionofthebalancesheet? D.Commonstockandretainedearnings. Commonstockandretainedearningsarereportedinthestockholders'equitysectionofthebalancesheet. 20. Anoptionalstepintheaccountingcycleisthepreparationof: D.Theworksheet. Thepreparationoftheworksheetisanoptionalpartintheaccountingcycle. 21. Allofthefollowingareexternaleventsexcept: B.Consumingrawmaterialsinproductionprocesses.
Consumingrawmaterialsinproductionprocessesisaninternalevent. 22. Postingistheprocessoftransferringitemsenteredinageneraljournaltothe: C.Generalledger. Postingistransferringitemsinageneraljournaltothegeneralledger. 23. Whichofthefollowingstatementsaboutatrialbalanceisincorrect? D.Itprovesthatalltransactionshavebeenrecorded. Atrialbalancedoesnotprovethatalltransactionshavebeenrecorded. 24. Anadjustingentrywouldneverincludea: D.Debittoanassetaccountandacredittoaliabilityaccount. Anadjustingentryincludingadebittoanassetaccountandacredittoaliabilityaccountwouldnever occurbecauseincomestatementamountswouldnotbeadjusted. 25. Theadjustingentrytorecordaccruedrevenueincludesadebitto: A.Anassetaccountandacredittoarevenueaccount. Theadjustingentryforaccruedrevenuesincludesadebittoanassetaccountandacredittoarevenue account. 26. Iftheadjustingentryforanaccruedexpenseisnotmade: C.Liabilitieswillbeunderstated. Liabilities(andexpensesalso)willbeunderstatediftheadjustingentryforanaccruedexpenseisnotmade.
Chapter 4
1.
The major elements of the income statement are A. revenue, cost of goods sold, selling expenses, and general expense. B. operating section, non-operating section, discontinued operations, and extraordinary items. C. revenues, expenses, gains, and losses. D. revenue, cost of goods sold, operating expenses, non-operating section.
2.
The single-step income statement emphasizes A. the gross profit and income from operations. B. total revenues and total expenses. C. extraordinary items and discontinued operations more than these are emphasized in the multiple-step income statement. D. the various components of income from continuing operations.
3.
Which of the following is an acceptable method of presenting the income statement? A. A single-step income statement B. A multiple-step income statement C. A condensed income statement D. All of these
4.
Classification as an extraordinary item on the income statement would be appropriate for the A. gain or loss on disposal of a component of the business. B. substantial write-off of obsolete inventories. C. loss from a strike. D. gain from condemnation settlement.
5.
Which of the following is true about intraperiod tax allocation? A. It arises because certain revenue and expense items appear in the income statement either before or after they are included in the tax return. B. It is required for extraordinary items and discontinued operations but not for prior period adjustments. C. Its purpose is to allocate income tax expense evenly over a number of accounting periods. D. Its purpose is to relate the income tax expense to the items which affect the amount of tax.
6.
Which of the following is a required disclosure in the income statement when reporting the disposal of a component of the business? A. The gain or loss on disposal should be reported as an extraordinary item. B. Results of operations of a discontinued component should be disclosed immediately below extraordinary items. C. Earnings per share for both continuing operations and net income should be disclosed on the face of the income statement. D. The gain or loss on disposal should not be segregated, but should be reported together with the results of continuing operations.
7.
Which one of the following types of losses is excluded from the determination of net income in income statements? A. Material losses resulting from transactions in the company's investments account. B. Material losses resulting from unusual sales of assets not acquired for resale. C. Material losses resulting from the write-off of intangibles. D. Material losses resulting from correction of errors related to prior periods.
8.
The approach most companies use to provide information related to the components of other comprehensive income is in a A. second separate income statement. B. combined income statement of comprehensive income. C. separate column in the statement of changes in stockholders' equity. D. footnote disclosure.
9.
Information in the income statement helps users to A. evaluate the past performance of the enterprise. B. provide a basis for predicting future performance. C. help assess the risk or uncertainty of achieving future cash flows. D. all of these.
10 .
For Wolverton Company, the following information is available: Cost of goods sold Dividend revenue $99,000 2,500
Income tax expense Operating expenses Sales In Wolverton's single-step income statement, gross profit A. will not be reported. B. will be reported at $16,000. C. will be reported at $18,000. D. will be reported at $71,000.
2,000 53,000 170,000
11.
The occurrence which most likely would have no effect on 2010 net income (assuming that all amounts involved are material) is the A. sale in 2010 of an office building contributed by a stockholder in 1986. B. collection in 2010 of a receivable from a customer whose account was written off in 2009 by a charge to the allowance account. C. settlement based on litigation in 2010 of previously unrecognized damages from a serious accident which occurred in 2008. D. worthlessness determined in 2010 of stock purchased on a speculative basis in 2006.
12.
How should an unusual event not meeting the criteria for an extraordinary item be disclosed in the financial statements? A. Shown as a separate item in operating revenues or expenses if material and supplemented by a footnote if deemed appropriate. B. Shown in operating revenues or expenses if material but not shown as a separate item. C. Shown net of income tax after ordinary net earnings but before extraordinary items. D. Shown net of income tax after extraordinary items but before net earnings.
13.
Cordoba Corporation has an extraordinary loss of $150,000, an unusual gain of $350,000, and a tax rate of 20%. At what amount should Cordoba report each item? Extraordinary loss Unusual gain A. $(150,000) B. (150,000) C. (120,000) D. (120,000) $350,000 280,000 350,000 280,000
14.
Reddaway Corporation reports the following information: Net income Dividends on common stock Dividends on preferred stock Weighted average common shares outstanding Reddaway should report earnings per share of A. $3.00. B. $3.60. C. $4.40. D. $5.00. $500,000 140,000 60,000 100,000
15.
Nguyen Corporation reports the following information: Correction of overstatement of depreciation expense in prior years, net of tax, $215,000 Dividends declared $160,000 Net income $500,000 Retained earnings, 1/1/12, as reported $1,000,000 Nguyen should report retained earnings, 12/31/12, at A. $785,000. B. $1,125,000. C. $1,340,000. D. $1,555,000.
16.
Stamey Company reported the following information for 2012: Sales revenue Cost of goods sold Operating expenses Unrealized holding gain on available-for-sale securities Cash dividends received on the securities For 2012, Stamey would report comprehensive income of A. $117,000. B. $115,000. C. $97,000. D. $20,000. $500,000 350,000 55,000 20,000 2,000
17.
Investors and creditors can use the information in the income statement to:
A. evaluate the past performance of the enterprise. B. provide a basis for predicting future performance. C. help assess the risk or uncertainty of achieving future cash flows. D. All of these.
Investors and creditors can use the information in the income statement for all of the options listed.
18.
Expenses include all of the following except: A. cost of goods sold. B. depreciation. C. loss on sale of investments. D. salaries and wages.
All of the options are expenses except the loss on sale of investments.
19.
In the single-step income statement: A. interest revenue and rental revenue are reported as other revenues and gains. B. just two groupings exist - revenues and expenses. C. expenses are classified by functions, such as merchandising, selling and administration. D. an income from operations figure is presented.
Just two groupings exist in the single-step income statement - revenues and expenses.
20.
Non-operating items include all of the following except: A. interest revenue. B. rent expense. C. rent revenue. D. interest expense.
Rent expense is an operating expense.
21.
Irregular transactions such as discontinued operations and extraordinary items should be reported separately
in: A. both a single-step and multiple-step income statement. B. a single-step income statement only. C. a multiple-step income statement only. D. neither a single-step nor a multiple-step income statement.
In both a single-step and multiple-step income statement, discontinued operations and extraordinary items should be separately reported.
22.
The gain or loss from disposal of a component of a business is shown as a (an): A. unusual gain or loss. B. part of discontinued operations. C. extraordinary item. D. prior period adjustment.
Discontinued operations include the gain or loss from disposal of a component of a business.
23.
All of the following would meet the criteria for an extraordinary item except gains or losses from: A. a major casualty. B. prohibition under a newly enacted law or regulation. C. an expropriation of assets. D. loss on exchange of foreign currencies.
All of the options would be classified as an extraordinary item except gains or losses from exchange of foreign currency.
24.
A change in the method of inventory pricing from FIFO to LIFO would be accounted for as a (an): A. part of discontinued operations. B. extraordinary item. C. change in accounting principle. D. change in estimate.
Changes in accounting principle would include a change in the method of inventory pricing.
25.
Intraperiod tax allocation is used for all of the following except: A. changes in accounting principle. B. discontinued operations. C. extraordinary items. D. unusual gains/losses.
Intraperiod tax allocation is applied to all of the options except unusual gains/losses.
26.
Which of the following statements related to extraordinary items and intraperiod tax allocation is correct? A. Extraordinary gains, but not extraordinary losses, are reported net of tax. B. Extraordinary losses, but not extraordinary gains, are reported net of tax. C. Both extraordinary gains and losses are reported net of tax. D. Neither extraordinary gains nor losses are reported net of tax.
Extraordinary gains and losses are reported net of any applicable income tax effects. Chapter 5 1. Which of the following is a limitation of the balance sheet? A. Many items that are of financial value are omitted. B. Judgments and estimates are used. C. Current fair values are not reported for many assets and liabilities. D. All of these
2.
The correct order to present current assets is A. Cash, accounts receivable, prepaid items, inventories. B. Cash, accounts receivable, inventories, prepaid items. C. Cash, inventories, accounts receivable, prepaid items. D. Cash, inventories, prepaid items, accounts receivable.
3.
Which of the following are acceptable balance sheet formats? A. Condensed form and report form.
B. Multiple step form and account form. C. Condensed form and multiple step form. D. Report form and account form.
4.
Which of the following balance sheet classifications would normally require the greatest amount of supplementary disclosure? A. Current assets B. Current liabilities C. Plant assets D. Long-term liabilities
5.
Which of the following is not a major disclosure technique for the balance sheet? A. Notes. B. Parenthetical explanations. C. Supporting schedules. D. Worksheets.
6.
The financial statement which summarizes the operating, investing, and financing activities of an entity for a period of time is the A. retained earnings statement. B. income statement. C. statement of cash flows. D. statement of financial position.
7.
Making and collecting loans and disposing of property, plant, and equipment are A. operating activities. B. investing activities. C. financing activities. D. liquidity activities.
8.
The issuance of stock and the payment of dividends are A. operating activities.
B. investing activities. C. stock activities. D. financing activities.
9.
The current cash debt coverage ratio is often used to assess A. financial flexibility. B. liquidity. C. profitability. D. solvency.
10.
The balance sheet is useful for analyzing all of the following except A. liquidity. B. solvency. C. profitability. D. financial flexibility.
11.
The basis for classifying assets as current or non-current is the period of time normally required by the accounting entity to convert cash invested in A. inventory back into cash, or 12 months, whichever is shorter. B. receivables back into cash, or 12 months, whichever is longer. C. tangible fixed assets back into cash, or 12 months, whichever is longer. D. inventory back into cash, or 12 months, whichever is longer.
12.
Which of the following balance sheet formats lists the assets on the left side of the page and the liabilities and stockholders' equity on the right side? A. Single step form. B. Account form. C. Multiple step form. D. Report form.
13.
Which of the following facts concerning fixed assets should be included in the summary of significant accounting policies?
Depreciation Method Composition A. No B. Yes C. Yes D. No Yes Yes No No
14.
A generally accepted account title is A. Prepaid Revenue. B. Appropriation for Contingencies. C. Earned Surplus. D. Reserve for Doubtful Accounts.
15.
The statement of cash flows provides answers to all of the following questions except A. Where did the cash come from during the period? B. What was the cash used for during the period? C. What is the impact of inflation on the cash balance at the end of the year? D. What was the change in the cash balance during the period?
16 .
Cortex Corporation reports: Cash provided by operating activities Cash used by investing activities Cash used by financing activities Beginning cash balance What is Cortez's ending cash balance? A. $720,000. B. $890,000. C. $1,530,000. D. $1,750,000. $1,150,000 320,000 110,000 170,000
17 .
Rover Corporation reports the following information: Net income Depreciation expense $2,500,000 340,000
Loss on the sale of investments Increase in accounts receivable
77,000 160,000
Rover should report cash provided by operating activities of A. $1,923,000. B. $2,500,000. C. $2,757,000. D. $3,077,000.
18 .
Nirvana Corporation reports the following information: Net cash provided by operating activities Average current liabilities Average long-term liabilities Dividends paid Capital expenditures Purchase of treasury stock Payments of debt Nirvana's free cash flow is A. $10,000. B. $45,000. C. $105,000. D. $155,000. $215,000 150,000 100,000 60,000 110,000 11,000 35,000
19.
Which of the following statements about the balance sheet is incorrect? A. It reports the assets, liabilities, and equity of a company for a period of time. B. It is sometimes referred to as the statement of financial position. C. It provides information about the nature and amounts of investments in resources, obligations to creditors, and the owners' equity. D. It helps in predicting the amounts, timing, and uncertainty of future cash flows.
The balance sheet reports information as of a specific date, not for a period of time.
20.
Major limitations of the balance sheet include all of the following except: A. most assets and liabilities are stated at historical cost.
B. judgments and estimates are used in determining many of the items reported. C. it necessarily omits many items that are of financial value but cannot be recorded objectively. D. only amounts known with certainty are reported.
All of the options are major limitations of the balance sheet except only amounts known with certainty are reported.
21.
Current assets are presented in the balance sheet in order of: A. dollar amounts. B. liquidity. C. solvency. D. the alphabet.
Current assets are presented in the balance sheet in order of liquidity.
22.
Which of the following investments should always be reported as current assets? A. Available-for-sale securities. B. Held-to-maturity securities. C. Long-term investments. D. Trading securities.
Trading securities should always be reported as current assets.
23.
All of the following would be classified as current liabilities at December 31, 2012 except: A. accrued warranty costs. B. advances received from customers. C. current portion of long-term debt. D. note payable due January 1, 2014.
The note payable due January 1, 2014 is not a current liability.
24.
All of the following are stockholders' equity sections reported in the balance sheet except:
A. additional paid-in-capital. B. capital stock. C. retained earnings. D. dividends.
Dividends are reported in the statement of stockholders' equity but are not a section of stockholders' equity reported on the balance sheet.
25.
The balance sheet format listing liabilities and stockholders' equity directly below assets is called the: A. account form. B. financial position form. C. report form. D. solvency form.
The report form lists liabilities and stockholders' equity below assets on the same page.
26.
Which of the following is not a type of information that is supplemental to amounts presented in the balance sheet? A. Accounting policies. B. Balance sheet format. C. Contingencies. D. Contractual situations.
All of the options are types of information that are supplemental to amounts presented except the balance sheet format.
27.
Companies are not required to disclose information about: A. inventory cost flow methods. B. depreciation methods. C. the identity of all stockholders. D. the use of estimates.
Companies are required to disclose information about all of the options except the identity of all stockholders.
Chapter 1
1.
The financial statements most frequently provided include all of the following except the A. balance sheet. B. statement of cash flows. C. statement of retained earnings. D. statement of stockholders' equity.
2.
An effective capital allocation process A. promotes innovation. B. provides an efficient market for obtaining and granting credit. C. encourages productivity. D. all of these.
3.
The objective of general purpose financial reporting adopts an entity perspective, which means that A. financial reporting should be focused an assessing the company's stewardship. B. financial reporting should be focused solely on the needs of the owners. C. companies are viewed as separate and distinct from their owners. D. none of these.
4.
Which of the following statements is not an objective of financial reporting? A. Provide information that is useful in investment and credit decisions. B. Provide information about enterprise resources, claims to those resources, and changes to them. C. Provide information on the liquidation value of an enterprise. D. Provide information that is useful in assessing cash flow prospects.
5.
Accounting principles are "generally accepted" only when A. an authoritative accounting rule-making body has established it in an official pronouncement. B. it has been accepted as appropriate because of its universal application. C. both of these. D. neither of these.
6.
The role of the Securities and Exchange Commission in the formulation of accounting principles can be best described as A. consistently primary. B. consistently secondary. C. sometimes primary and sometimes secondary. D. non-existent.
7.
Generally accepted accounting principles A. include detailed practices and procedures as well as broad guidelines of general application. B. are influenced by pronouncements of the SEC and IRS. C. change over time as the nature of the business environment changes. D. all of these.
8.
Financial accounting standard-setting in the United States A. can be described as a social process which reflects political actions of various interested user groups as well as a product of research and logic. B. is based solely on research and empirical findings. C. is a legalistic process based on rules promulgated by governmental agencies. D. is democratic in the sense that a majority of accountants must agree with a standard before it becomes enforceable.
9.
What group or organization governs the ethical issues in financial accounting? A. The Securities and Exchange Commission (SEC). B. The American Institute of Certified Public Accountants (AICPA). C. The Financial Accounting Standards Board (FASB). D. The Government Accounting Standards Board (GASB).
10.
The information provided by financial reporting pertains to A. individual business enterprises, rather than to industries or an economy as a whole or to members of society as consumers. B. business industries, rather than to individual enterprises or an economy as a whole or to members of society as consumers. C. individual business enterprises, industries, and an economy as a whole, rather than to members of society as consumers. D. an economy as a whole and to members of society as consumers, rather than to individual enterprises
or industries.
11.
An effective capital allocation process A. promotes productivity. B. encourages innovation. C. provides an efficient market for buying and selling securities. D. all of these.
12.
Issues in financial reporting include A. the expectations gap. B. the economic consequences of accounting rules. C. political pressure from users. D. all of these.
13.
Accrual accounting is used because A. cash flows are considered less important. B. it provides a better indication of ability to generate cash flows than the cash basis. C. it recognizes revenues when cash is received and expenses when cash is paid. D. none of these.
14.
A common set of accounting standards and procedures are called A. financial accounting standards. B. generally accepted accounting principles. C. objectives of financial reporting. D. statements of financial accounting concepts.
15.
Which of the following statements about the FASB's Codification is true? A. The Codification provides all of the authoritative literature on a topic in one place. B. The Codification creates new GAAP. C. The Codification includes International Financial Reporting Standards. D. All of these statements are true.
16.
Which of the following publications does not qualify as a statement of generally accepted accounting principles? A. Statements of financial standards issued by the FASB B. Accounting interpretations issued by the FASB C. APB Opinions D. Accounting research studies issued by the AICPA
17.
The purpose of the International Accounting Standards Board is to A. issue enforceable standards which regulate the financial accounting and reporting of multinational corporations. B. develop a uniform currency in which the financial transactions of companies through-out the world would be measured. C. promote uniform accounting standards among countries of the world. D. arbitrate accounting disputes between auditors and international companies.
18.
From the four statements that follow, which grouping is true? 1. Technical competence is not enough when encountering ethical decisions. 2. The pressures to bend the rules, to play the game, to just ignore it can be considerable. 3. Time, job, client, personal, and peer pressures do not complicate the process of ethical sensitivity and selection among alternatives. 4. The decision may be easier because there is no comprehensive ethical system to provide guidelines. A. 1, 2, 3, and 4 are all true. B. 1, 2, and 4 are all true. C. 2 and 4 are true. D. 1 and 2 are true.
19.
The financial statements most frequently provided include all of the following except the: A. balance sheet. B. statement of cash flows. C. statement of retained earnings. D. statement of stockholders' equity.
The most frequently provided financial statements include all of the options except the statement of retained earnings.
20.
An effective process of capital allocation is critical to a healthy economy, which: A. promotes productivity. B. encourages innovation. C. provides an efficient and liquid market for buying and selling securities. D. All of the options are correct.
An effective process of capital allocation is critical to a healthy economy, which results in all of the options listed.
21.
GAAP includes all of the following except: A. FASB Technical Bulletins. B. SEC Statements on Accounting Positions. C. AICPA-SEC Practice Bulletins. D. AICPA Accounting Research Bulletins.
GAAP does not include SEC Statements on Accounting Positions.
22.
All of the following are objectives of financial reporting except to provide information: A. about enterprise resources, claims to those resources, and changes in them. B. that is useful in investment and credit decisions. C. about the management and major shareholders of an enterprise. D. that is useful in assessing cash flow prospects.
Objectives of financial reporting include all of the options except providing information about the management and major shareholders.
23.
The term GAAP means: A. generally accepted accounting practices. B. generally accepted accounting principles. C. generally accepted auditing practices. D. generally accepted accounting purposes.
GAAP means generally accepted accounting principles.
24.
Which one of the following organizations has not been instrumental in the development of financial accounting standards? A. AICPA. B. FASB. C. IMA. D. SEC.
All of the options have been instrumental in the development of financial accounting standards except the IMA.
25.
Which of the following was established by the federal government to help develop and standardize financial information presented to stockholders? A. AICPA. B. FASB. C. GASB. D. SEC.
As a result of the call for greater regulation after the stock market crash of 1929, the federal government established the SEC to help develop and standardize financial information for stockholders. Chapter 2
1.
Generally accepted accounting principles A. are fundamental truths or axioms that can be derived from laws of nature. B. derive their authority from legal court proceedings. C. derive their credibility and authority from general recognition and acceptance by the accounting profession. D. have been specified in detail in the FASB conceptual framework.
2.
In the conceptual framework for financial reporting, what provides "the why"--the goals and purposes of accounting? A. Measurement and recognition concepts such as assumptions, principles, and constraints B. Qualitative characteristics of accounting information C. Elements of financial statements
D. Objective of financial reporting
3.
Enhancing qualities include all of the following except A. timeliness B. comparability. C. verifiability. D. materiality.
4.
In order to be relevant, financial information must have all of the following ingredients of fundamental qualities except A. be free from error. B. have predictive value. C. be material. D. have confirmatory value.
5.
A decrease in net assets arising from peripheral or incidental transactions is called a(n) A. capital expenditure. B. cost. C. loss. D. expense.
6.
Under current GAAP, inflation is ignored in accounting due to the A. economic entity assumption. B. going concern assumption. C. monetary unit assumption. D. periodicity assumption.
7.
Revenue is generally recognized when realized or realizable and earned. This statement describes the A. completeness characteristic. B. matching principle. C. revenue recognition principle.
D. relevance characteristic.
8.
Which of the following statements concerning the cost-benefit relationship is not true? A. Business reporting should exclude information outside of management's expertise. B. Management should not be required to report information that would significantly harm the company's competitive position. C. Management should not be required to provide forecasted financial information. D. If needed by financial statement users, management should gather information not included in the financial statements that would not otherwise be gathered for internal use.
9.
Which of the following is/are not true concerning a conceptual framework in accounting? A. It should be a basis for standard-setting. B. It should allow practical problems to be solved more quickly by reference to it. C. It should be based on fundamental truths that are derived from the laws of nature. D. All of these are true.
10.
Which level of the conceptual framework is devoted to recognition and measurement concepts? A. 4th B. 3rd C. 2nd D. 1st
11.
The underlying theme of the conceptual framework is A. decision usefulness. B. understandability. C. reliability. D. comparability.
12.
Accounting information is considered to be relevant when it A. can be depended on to represent the economic conditions and events that it is intended to represent. B. is capable of making a difference in a decision. C. is understandable by reasonably informed users of accounting information.
D. is verifiable and neutral.
13.
One of the elements of financial statements is comprehensive income. As described in Statement of FinancialAccounting Concepts No. 6, "Elements of Financial Statements," comprehensive income is equal to A. revenues minus expenses plus gains minus losses. B. revenues minus expenses plus gains minus losses plus investments by owners minus distributions to owners. C. revenues minus expenses plus gains minus losses plus investments by owners minus distributions to owners plus assets minus liabilities. D. none of these.
14.
Preparation of consolidated financial statements when a parent-subsidiary relationship exists is an example of the A. economic entity assumption. B. relevance characteristic. C. comparability characteristic. D. neutrality characteristic.
15.
"When products (goods or services), merchandise, or other assets are exchanged for cash or claims to cash" is a definition of A. allocated revenue. B. realized revenue. C. realizable revenue. D. earned revenue.
16.
Expensing the cost of a wastebasket with an estimated useful life of 10 years as an expense of the period when purchased is an example of applying the A. consistency characteristic. B. expense recognition principle. C. materiality quality. D. historical cost principle.
17.
All of the following statements about the conceptual framework are correct except it:
A. is a coherent system of interrelated objectives and fundamentals that can lead to consistent standards. B. prescribes the nature, function, and limits of financial accounting and financial statements. C. increases financial statement users' understanding of and confidence in financial reporting. D. All of these options are correct.
A conceptual framework includes all of the options listed. 18. The first level of the conceptual framework is the: A. elements of financial statements. B. objective of financial reporting. C. qualitative characteristics of accounting information. D. recognition and measurement concepts.
The objective of financial reporting is the first level of the conceptual framework. 19. Which of the following is an ingredient of the fundamental quality of faithful representation? A. freedom from error. B. predictive value. C. materiality. D. confirmatory value.
Freedom from error is an ingredient of the fundamental quality of faithful representation. 20. All of the following are ingredients of relevance except: A. feedback value. B. predictive value. C. materiality. D. neutrality.
Neutrality is an ingredient of faithful representation, not relevance. 21. Enhancing qualities of accounting information include: A. comparability and verifiability. B. cost/benefits and materiality.
C. relevance and faithful representation. D. completeness and neutrality.
Comparability and verifiability are the enhancing qualities of accounting information.
22.
Which of the following statements about comprehensive income is incorrect? A. It is more inclusive than the traditional notion of net income. B. Unrealized holding gains on available-for-sale securities are included in comprehensive income. C. It includes all changes in equity during a period except net income. D. Changes in equity of an entity during a period from transactions and other events from nonowner sources are included in comprehensive income.
Comprehensive income includes net income and all other changes in equity exclusive of owners' investments and distributions. 23. Increases in equity from peripheral or incidental transactions of an entity are: A. expenses. B. gains. C. investments by owners. D. revenues.
Gains are increases in equity from peripheral or incidental transactions. 24. Depreciation and amortization policies are justifiable and appropriate because of the: A. economic entity assumption. B. going concern assumption. C. monetary unit assumption. D. periodicity assumption.
The going concern assumption is the justification for depreciation and amortization.
25.
The assumption that implies that the economic activities of an enterprise can be divided into artificial time periods is the: A. economic entity assumption. B. going concern assumption.
C. monetary unit assumption. D. periodicity assumption.
The periodicity assumption implies that the economic activities of an enterprise can be divided into artificial time periods. 26. Generally, revenue should be recognized: A. during production. B. at the end of production. C. at the time of sale. D. at the time cash is received.
Usually, revenue is recognized at the time of sale. 27. Generally, expenses are recognized when the: A. wages are paid. B. work is performed. C. product is produced. D. work or product actually makes its contribution to revenue.
Expenses are recognized when the work or product actually makes its contribution to revenue.

E5-3 (Classification of Balance Sheet Accounts) Assume that Masters Enterprises uses the following headings on its balance sheet. (a) (b) (c) (d) (e) Current assets. Investments. Property, plant, and equipment. Intangible assets. Other assets. (f) (g) (h) (i) (j) Current liabilities. Long-term liabilities. Capital stock. Paid-in capital in excess of par Retained earnings.
Indicate by letter how each of the following usually should be classified. If an item should appear in a note to the financial statements, use the letter "n" to indicate this fact. If an item need not be reported at all on the balance sheet, use the letter "x."
AE4-9 (Earnings Per Share with Dividends) The stockholders' equity section of Sosa Corporation appears below as of December 31, 2012. 6% preferred stock, $50 par value, authorized 100,520 shares, outstanding 90,520 shares Common stock, $1 par, authorized and issued 10.33 million shares Additional paid-in capital Retained earnings Net income
$4,526,000 10,330,000 20,830,400 $134,537,800 33,518,600 168,056,400 $203,742,800
Net income for 2012 reflects a total effective tax rate of 34%. Included in the net income figure is a loss of $12,021,200 (before tax) as a result of a major casualty, which should be classified as an extraordinary item. Preferred stock dividends of $271,560 were declared and paid in 2012. Dividends of $1,500,000 were declared and paid to common stockholders in 2012. Compute earnings per share data as it should appear on the income statement of Sosa Corporation.
AE4-11 (Retained Earnings Statement) McEntire Corporation began operations on January 1, 2009. During its first 3 years of operations, McEntire reported net income and declared dividends as follows. Net income $43,600 127,400 161,300 Dividends declared $ -054,900 59,600
2009 2010 2011
The following information relates to 2012. Income before income tax Prior period adjustment: understatement of 2010 depreciation expense (before taxes) Cumulative decrease in income from change in inventory methods (before taxes) Dividends declared (of this amount, $25,000 will be paid on Jan. 15, 2013) Effective tax rate (a) Prepare a 2012 retained earnings statement for McEntire Corporation. $241,000 $30,700 $35,300 $100,000 40%
(b) Assume McEntire Corp. restricted retained earnings in the amount of $70,000 on December 31, 2012. After this action, what would McEntire report as total retained earnings in its December 31, 2012, balance sheet?
Unit 1 Review Problem Attempt to work this problem before you do the practice problems and the graded homework problems at WileyPLUS. Transaction AnalysisService Company Martin is a licensed CPA. During the first month of operations of her business (a sole proprietorship), the following events and transactions occurred. May 1 Invested $65,600 cash and equipment valued at $22,200 in the business. 2 Hired a secretary-receptionist at a salary of $750 per week, payable monthly. 4 Purchased supplies on account $1,500. (Debit an asset account.) 8 Paid office rent of $1,750 for the month. 10 Completed an audit assignment and billed client $3,300 for services rendered. (Use Service Revenue account.) 13 Received $6,500 in advance on a tax consulting engagement. 18 Received cash of $4,500 for services completed for Logan Co. 22 Paid insurance expense $420. 29 Paid secretary-receptionist $3,000 for the month. 30 A count of supplies indicated that $350 of supplies had been used. 30 Purchased a new computer for $7,500 with personal funds. (The computer will be used exclusively for business purposes.)
Review Problem Solution May 1 Cash Equipment .............................................................................................................................................. Martin, Capital ...................................................................................................................... 65,600 22,000 87,600
No entrynot a transaction.
Supplies ................................................................................................................................................... Accounts Payable ................................................................................................................
1,500 1,500
Rent Expense ......................................................................................................................................... Cash ..........................................................................................................................................
1,750 1,750
10
Accounts Receivable ........................................................................................................................... Service Revenue ...................................................................................................................
3,300 3,300
13
Cash Unearned Service Revenue ..............................................................................................
6,500 6,500
18
Cash Service Revenue ...................................................................................................................
4,500 4,500
22
Insurance Expense ............................................................................................................................... Cash ..........................................................................................................................................
420 420
39
Salaries Expense ................................................................................................................................... Cash ..........................................................................................................................................
3,000 3,000
30
Supplies Expense ................................................................................................................................. Supplies ...................................................................................................................................
350 350
30
Equipment .............................................................................................................................................. Martin, Capital ......................................................................................................................
7,500 7,500
Unit1OnlinePractice
E 4-4 Two accountants for the firm of Allen and Wright are arguing about the merits of presenting an income statement in a multiple-step versus a single-step format. The discussion involves the following 2012 information related to Webster Company ($000 omitted). Administrative expense Officer's salaries $4,900 Depreciation of office furniture and equipment 3,960 Cost of goods sold 63,570 Rental revenue 17,230 Selling expense Transportation-out 2,690 Sales commissions 7,980 Depreciation of sales equipment 6,480 Sales 96,500 Income tax 7,580 Interest expense 1,860 Prepare an income statement for the year 2012 using the multiple-step form. Common shares outstanding for 2012 total 40,550 (000 omitted). Prepare an income statement for the year 2012 using the single-step form.
(a) (b)
E 4-7Presented below are selected ledger accounts of McGraw Corporation as of December 31, 2012. Cash $50,000 Administrative expenses 100,000 Selling expenses 80,000 Net sales 540,000 Cost of goods sold 260,000 Cash dividends declared (2012) 20,000 Cash dividends paid (2012) 15,000 Discontinued operations (loss before 40,000 income taxes) Depreciation expense, not recorded in 30,000 2011 Retained earnings, December 31, 2011 90,000 Effective tax rate 30% Compute net income for 2012. Prepare a partial income statement beginning with income from continuing operations before income tax, and
(a) (b) 2012.
including appropriate earnings per share information. Assume 20,000 shares of common stock were outstanding during
E 4-8 (Multiple-step Statement with Retained Earnings) Presented below is information related to Brokaw Corp. for the year 2012. Write-off inventory due to obsolescence $80,000 Depreciation expense omitted by accident in 40,000 2011 Selling expenses 65,000 Casualty loss (extraordinary item) before taxes 50,000 Administrative expenses 48,000 Dividends declared 45,000 Dividend revenue 20,000 Retained earnings at December 31, 2011 980,000 Interest revenue 7,000 Effective tax rate of 34% on all items Prepare a multiple-step income statement for 2012. Assume that 60,000 shares of common stock are outstanding. Prepare a separate retained earnings statement for 2012. Net sales Cost of goods sold $1,200,000 780,000
(a) (b)
E5-4 Prepare a classified balance sheet in good form.
780,300
Correct Answer for (i): Faithful Representation
Unit 1 Review Problem Attempt to work this problem before you do the practice problems and the graded homework problems at WileyPLUS. Transaction AnalysisService Company Martin is a licensed CPA. During the first month of operations of her business (a sole proprietorship), the following events and transactions occurred. May 1 Invested $65,600 cash and equipment valued at $22,200 in the business. 2 Hired a secretary-receptionist at a salary of $750 per week, payable monthly. 4 Purchased supplies on account $1,500. (Debit an asset account.) 8 Paid office rent of $1,750 for the month. 10 Completed an audit assignment and billed client $3,300 for services rendered. (Use Service Revenue account.) 13 Received $6,500 in advance on a tax consulting engagement. 18 Received cash of $4,500 for services completed for Logan Co. 22 Paid insurance expense $420. 29 Paid secretary-receptionist $3,000 for the month. 30 A count of supplies indicated that $350 of supplies had been used. 30 Purchased a new computer for $7,500 with personal funds. (The computer will be used exclusively for business purposes.)
Review Problem Solution May 1 Cash Equipment .............................................................................................................................................. Martin, Capital ...................................................................................................................... 65,600 22,000 87,600
No entrynot a transaction.
Supplies ................................................................................................................................................... Accounts Payable ................................................................................................................
1,500 1,500
Rent Expense ......................................................................................................................................... Cash ..........................................................................................................................................
1,750 1,750
10
Accounts Receivable ........................................................................................................................... Service Revenue ...................................................................................................................
3,300 3,300
13
Cash Unearned Service Revenue ..............................................................................................
6,500 6,500
18
Cash Service Revenue ...................................................................................................................
4,500 4,500
22
Insurance Expense ............................................................................................................................... Cash ..........................................................................................................................................
420 420
39
Salaries Expense ................................................................................................................................... Cash ..........................................................................................................................................
3,000 3,000
30
Supplies Expense ................................................................................................................................. Supplies ...................................................................................................................................
350 350
30
Equipment .............................................................................................................................................. Martin, Capital ......................................................................................................................
7,500 7,500
Acct. 3401 -Intermediate Accounting I Chapter 2, Exercise 3 Question (a) (b) (c) What is the quality of information that enables users to confirm or correct prior expectations? Identify the pervasive constraint(s) developed in conceptual framework The chairman of the SEC at one time noted, If it becomes accepted or expected that accounting principles are determined or modified in order to secure purposes other than economic measurement, we assume a grave risk that confidence in the credibility of our financial system will be undermined. Which qualitative characteristic of accounting information should ensure that such a situation will not occur? (Do not use reliability.) Muruyama Corp. switches from FIFO to average cost to FIFO over a 2year period. Which qualitative characteristic of accounting information is not followed? Assume that the profession permits the savings and loan industry to defer losses on investments it sells, because immediate recognition of the loss may have adverse economic consequences on the industry. Which qualitative characteristic of accounting information is not followed? (Do not use relevance or representationally faithful.) What are the two primary qualities that make accounting information useful for decision making? Watteau, Inc. does not issue its first-quarter report until after the second quarters results are reported. Which qualitative characteristic of accounting is not followed? (Do not use relevance) Predictive value is an ingredient of which of the two primary qualities that make accounting information useful for decision-making purposes? Duggan, Inc. is the only company in its industry to depreciate its plant assets on a straight-line basis. Which qualitative characteristic of accounting information may not be followed? (Do not use industry practices.) Roddick Company has attempted to determine cost of its inventory. Three different appraisers arrive at substantially different amounts for this value. The president, nevertheless, decides to report the middle value for external reporting purposes. Which qualitative characteristic of information is lacking in these data? Do not use reliability or representational faithfulness.) Answer Confirmatory Value Cost Neutrality
(d)
Comparability (Consistency) Neutrality
(e)
(f)
Relevance and Faithful Representation Timeliness
(g)
(h) (i)
Relevance Comparability
(j)
Verifiability
ACCT 5325 Intermediate Financial Accounting I

1
Unit 1: The Accounting Information System
Learning Objectives
2
1. 2.
3. 4. 5.
6.
Overview of the accounting information system. Understand the double-entry accounting system and the accounting equation. Discuss the steps in the accounting cycle. Analyze and record transactions in the journal. Post transactions from the journal to the ledger accounts. Prepare an unadjusted trial balance.
Overview of the Accounting Information System

3
Collects and processes transaction data that impacts the entity. Provides financial information to interested parties.

Management Investors Creditors Securities and Exchange Commission (SEC) Internal Revenue Service (IRS)
Accounting Terminology
4
Event Transaction Account Elements of Accounting

Real Accounts Assets, Liabilities, and Equity Nominal Accounts Revenue, Expense, and Dividends
Journalizing Posting Trial Balance
Double-Entry Accounting System

5
Every transaction affects at least two accounts Debits (Dr.) and Credits (Cr.) Left and Right At least one account is debited and credited Debit = Credits
Debits and Credits

6
Normal Balance Debit
Normal Balance Credit
Expenses

7
Assets
Assets:
Cash Accounts Receivables Inventory
Liabilities
Equity
Equity:
Common Stock Additional Paid-in-Capital Retained Earnings
Property, Plant & Equipment
Liabilities:
Accounts Payable Taxes Payable Notes Payable Interest Payable

8
Assets = Liabilities + Equity
Steps in the Accounting Cycle

9
Journalize transactions Post from the journal to the ledger accounts Prepare an unadjusted trial balance Determine adjustments (journalize and post) Prepare adjusted trial balance Prepare financial statements Closing entries (journalize and post) Post-closing trial balance Reversing entries (optional)
Analysis of Transactions
10
External Event
Exchange between a company and its environment.

Customer makes a payment on accounts receivable. Borrows money from the bank.
Internal Event
Internally generated event to be recorded.

Depreciation recorded for use of equipment. Interest owed on note payable is calculated and recorded.
Not Recorded
Does not impact entitys accounts.
Hirings of new CEO for $175,000.
11
Determine if it is an internal or external event that needs to be recorded. Identify accounts impacted and direction (+) or (-). Determine whether accounts need to be debited or credited. Accounting equation should remain balanced after each transaction is recorded.
12
Problem 1: Kelly Repair Shop had the following transactions during the first month of business as a corporation. Analyze the following transactions and determine which accounts should be debited or credited and the impact on the accounting equation.
Aug. 2 7 12 18 25 Shareholders invested $12,000 cash and $2,500 of equipment in the corporation. Purchased supplies on account for $500. Performed services for clients, for which, $1,500 was collected in cash and $500 was billed to the client. Paid August rent of $700. Hired a receptionist at a salary of $500 per week.
13
Problem 1 (cont.) Aug. 2 Shareholders invested $12,000 cash and $2,500 of equipment in the corporation. Assets = Liabilities + Equity
Cash (+) Dr. $12,000 Equipment (+) Dr. $2,500
Common Stock (+) Cr. $14,500
14
Problem 1 (cont.) Aug. 7 Purchased supplies on account for $500. = Liabilities + Equity
Assets
Supplies (+) Dr. $500
Accounts Payable (+) Cr. $500
15
Problem 1 (cont.) Aug. 12 Performed services for which $1,500 was collected in cash and $500 was billed to the client. = Liabilities + Equity
Assets
Cash (+) Dr. $1,500 Accounts Receivable (+) Dr. $500
Revenue (+) Cr. $2,000
16
Problem 1 (cont.) Aug. 18 Paid August rent of $700 = Liabilities + Equity
Assets
Cash (-) Cr. $700
Rent Expense (+) Dr. $700
17
Problem 1 (cont.) Aug. 25 Hired a receptionist at a salary of $300 per week. = Liabilities + Equity
Assets
Nothing to record until work is performed by the receptionist.
Journalizing
18
General Journal - Chronological listing of recorded transactions.

The following journal entries illustrate the formal entries that would be entered or journalized in the general journal for problem 1. General Journal
Date 2010 Aug. 2 Account Titles and Explanation Cash Equipment Common Stock (Issued shares of stock for cash and equipment) Ref. Debit 12,000 2,500
J1
Credit
14,500
Journalizing
19
Date 2010 Aug 7
General Journal Account Titles and Explanation

Supplies Accounts Payable (Purchased Supplies on Account) Cash Accounts Receivable Sales Revenue (Performed services for cash and on account) Rent Expense Cash (Paid monthly rent)
Ref.
Debit 500
J1 Credit
500
12
1,500 500
2,000
18
700
700
Posting to the Ledger

20
Posting- Transferring amounts from the general journal to the general ledger accounts.
General Journal
Date 2010 Aug. 2 Account Titles and Explanation Cash Equipment Common Stock (Issued shares of stock for cash and equipment) Ref. 101 301 510 Debit 12,000 2,500
J1
Credit
14,500
Posting to the Ledger

21
General Ledger
Cash Date Aug 2 Explanation Ref. J1 Debit 12,000 Credit No.101 Balance -012,000 No.301 Ref. J1 Common Stock Date Aug 2 Explanation Ref. J1 Debit Credit 14,500 Debit 2,500 Credit Balance -02,500 No.510 Balance -014,500
Equipment Date Aug 2 Explanation
Unadjusted Trial Balance

22
Unadjusted Trial Balance A listing of all the general ledger accounts and their debit or credit balances prior to end of the period adjusting entries.
Unadjusted Trial Balance December 31, 2010

Cash Accounts Receivable Supplies Prepaid Insurance Office Equipment Accumulated DepreciationOffice Equipment Accounts Payable Notes Payable Unearned Revenue Common Stock Retained Earnings Sales Revenue Rent Expense Depreciation Expense Insurance Expense Debit $110,000 23,000 500 1,500 25,500 Credit
Thompson Inc.
12,000 2,000 3,000 $177,500
$5,000 10,000 15,000 3,000 60,000 36,500 43,000
$177,500

1
Unit 2: Accrual Aspects of Accounting
Learning Objectives
2
1. 2. 3.
4. 5. 6. 7.
8.
9.
Overview of the adjustment process. Prepare adjusting entries for Prepaid Expenses. Prepare adjusting entries for Unearned Revenues. Prepare adjusting entries for Accrued Revenues. Prepare adjusting entries for Accrued Expenses. Prepare an adjusted trial balance. Create financial statements from the trial balance. Prepare closing entries and the post closing trial balance. Explain the difference between the cash basis of accounting and the accrual basis of accounting.
Overview of the Adjustment Process

3
Adjusting entries recorded at the end of an accounting period to ensure that the revenue recognition and the matching principle are followed according to accrual accounting.
Deferrals

Prepaid Expenses Unearned Revenue Accrued Revenue Accrued Expenses
Accruals

Deferrals vs. Accruals

4
Deferrals - Cash paid or received before the adjustment.

Prepaid
expenses asset Unearned revenues liability
Accruals Cash paid or received after the adjustment.

Accrued
Revenues asset Accrued Expenses - liability
Prepaid Expense Adjusting Entry

5
Prepaid expenses are recorded as assets before being consumed.

Insurance Supplies Advertising Rent Fixed Assets
To adjust prepaid expenses, determine the amount used during the current period Typical adjusting entry:
______ Expense (+E, -SE) Prepaid Expense (-A)
XXX XXX

6
Insurance . A 2 year insurance policy was purchased on 9/1/10 for $2,400. Prepaid insurance was debited for the full amount. The journal entry is as follows:
Sept. 1 Prepaid Insurance (+A) Cash (-A) 2,400 2,400
What should the adjusting journal entry be at 12/31/10?

7
Insurance . Four out of the twenty-four month policy was used during the period. The adjustment is [(4/24) * $2,400]= $400. The adjusting entry is as follow:
Dec. 31 Insurance Expense (+E, -SE) Prepaid Insurance (-A) Prepaid Insurance
Debit 2,400 2,000 Credit_ 400
400 400
Credit_
Insurance Expense
Debit 400

8
Supplies . Supplies costing $1,500 were purchased on 9/15/10. A supplies inventory account was debited for the purchase.
Sept. 15 Supplies (+A) Cash (-A) 1,500 1,500
If a count revealed $800 supplies remaining on 12/31/10, what should the adjusting journal entry be at 12/31/10?

9
Supplies . (1,500 -800 = 700). $700 must be expensed since $800 of supplies remain on hand.
Dec. 31 Supplies Expense (+E, -SE) Supplies (-A) Supplies
Debit 1,500 800 Credit_ 700
700 700
Supplies Expense
Debit 700 Credit _

10
Equipment . Machinery was purchased on 8/1/10 for $6,500 with a salvage value of $500 and an expected useful life of 5 years. The machinery account was debited for $6,500.
Aug. 15 Machinery (+A) Cash (-A) 6,500 1,500
Straight-line depreciation is calculated as follows: (Cost Salvage)/Life * (months/12)
What should the adjusting entry be at 12/31/10?

11
Equipment. [(6,500 -500)/5] * 5/12= 500

Dec. 31 Depreciation Expense (+E, -SE) Accumulated Depr. (+XA, -A) 500 500
Accumulated Depr.
Debit Credit_ 500
Depreciation Expense
Debit 500 Credit _
Unearned Revenue Adjusting Entry

12
Unearned revenues are recorded as a liability when the cash is collected until services earned.

Customer deposits Airline tickets Magazine subscriptions Rent Season football tickets
To adjust unearned revenue, determine the amount earned during the current period Typical adjusting entry:
Unearned Revenue (-L) Revenue (+R, +SE)
XXX XXX

13
Rent Revenue. On 11/1/10 the company collected 4 months of $600 a month rent. It was credited to an unearned revenue account.
Nov. 1 Cash (+A) 2,400 2,400
Unearned Rent Revenue (+L)

14
Rent Revenue. (2/4 * 2,400) = 1,200

Dec. 31 Unearned Rent Revenue (-L) 1,200 Rent Revenue (+R, +SE) 1,200 Rent Revenue
Debit Credit _ 1,200
Unearned Rent Revenue

Debit 1,200 1,200 Credit_ 2,400
Accrued Revenue Adjusting Entry

15
Accrued revenues are earned revenues that have not been collected in cash or recorded.

Interest Services Rent
A receivable and revenue are recorded for the amount earned but not collected yet. Typical adjusting entry:
________
receivable (+A) XXX _______ Revenue (+R, +SE) XXX

16
Service Revenue. At 12/31/10, $2,000 of services had been performed for customers but not collected or recorded.

17
Service Revenue.
Dec. 31 Accounts Receivable (+A) Sales Revenue (+R, +SE) 2,000 2,000
Accounts Receivable
Debit 35,000 2,000 37,000 Credit_
Sales Revenue
Debit Credit _ 103,000 2,000 105,000
Accrued Expense Adjusting Entry

18
Accrued expenses are expenses that have been incurred but not yet paid.

Interest Taxes Rent Salaries Bad Debts (Cr. Allowance for Doubtful Accounts)
A payable and an expense are recorded for the amount incurred but not paid. Typical adjusting entry:
______ Expense (+E, -SE) _______ Payable (+L)
XXX XXX

19
Interest Expense. On 10/1/10 ABC Company borrowed $100,000 for 5 years at an annual rate of 6% to be paid each 9/30. (Principal * Rate * X/12)

20
Interest Expense.
($100,000 * .06 * 3/12) = $1,500
Dec. 31
Interest Expense (+E, -SE) Interest Payable (+L)
1,500 1,500
Interest Payable
Debit Credit_ 1,500
Interest Expense
Debit 1,500 Credit _

21
Salaries. The payroll was $1,000 a day which is paid for a 5 day work week. On Wednesday December 31,2010 there remained three days of unpaid salaries.

22
Salaries.
($1,000 * 3 days) = $3,000
Dec. 31
Salaries Expense (+E, -SE) Salaries Payable (+L)
3,000 3,000
Salaries Payable _Debit

Credit 3,000
Salaries Expense
Debit 3,000 Credit _
Adjusted Trial Balance

23
K,W,W, 13th Ill. 3-33
24
These financial statements are prepared from the information from the adjusted trial balance. Income Statement
Revenues Expenses = Net Income (Loss)
Statement of Retained Earnings
Beginning Retained Earnings +(-) Net Income (Loss) Dividends = Ending Retained Earnings
Balance Sheet
Assets = Liabilities + Equity
25
K,W,W, 13th Ill. 3-34
26
K,W,W, 13th, Ill. 3-35
Closing Process
27
In the closing process of the accounting cycle all temporary accounts are closed to the retained earnings accounts so that only balance sheet (permanent) accounts remain with balances to carryover to the next period.
Revenue and expense accounts are closed either directly to retained earnings or to an income summary account that is then closed to retained earnings. Dividends is closed directly to retained earnings.
Closing Entries
28
General Journal
Date
Oct 31
J3
Debit
106,000
Account Titles and Explanation

Service Revenue Income Summary (To close revenue account) Income Summary Advertising Supplies Expense Depreciation Expense Insurance Expense Salaries Expense Rent Expense Interest Expense Bad Debt Expense (To close expense accounts) Income Summary Retained Earnings (To close net income to retained earnings) Retained Earnings Dividends (To close dividends to retained earnings) K,W,W, 13th Ill. 3-36
Credit
106,000
31
73,000
15,000 400 500 46,000 9,000 500 1,600
31
33,000
33,000
31
5,000
5,000
Post-Closing Trial Balance

29
Accrual vs. Cash Basis Accounting

30
Cash Basis

Revenues recorded when received in cash Expenses recorded when paid in cash
Accrual Basis (required by GAAP)

Revenues recorded in the period earned Expenses recorded in the period incurred
Accrual vs. Cash Basis Accounting

31
Converting Cash Receipts to Accrual Service Revenue
Cash receipts from customers

- Beginning accounts receivable +Ending Accounts Receivable +Beginning Unearned Revenue -Ending Unearned Revenue
Converting Cash Expenses to Accrual Expenses
Cash paid for operating expenses

+Beginning prepaid expenses - Beginning accrued liabilities - Ending prepaid expenses +Ending accrued liabilities

1
Unit 3: Financial Statements
Learning Objectives
2
Income Statement and Retained Earnings Statement

Identify the uses and the limitations of the income statement. Prepare a single-step and a multi-step income statement. Understand the reporting of irregular items on the income statement. Explain intraperiod tax allocation. Identify earnings per share disclosures. Prepare a retained earnings statement.
1.
2.
3.
4. 5. 6.
Learning Objectives
3
1.
Balance Sheet and Cash Flow Statement

Identify the uses and the limitations of the balance sheet. Identify the major classifications of the balance sheet. Prepare a classified balance sheet. Determine which balance sheet information requires additional disclosure and techniques of disclosure. Understand the purpose and the content of the cash flow statement.
2.
3. 4.
5.
Uses and Limitations of the Income Statement

4
Income Statement measures the operating success of a company for a specific period of time.
Usefulness
Evaluate past performance Basis for predicting future performance Helps in the assessment of the uncertainty of achieving future cash flows
Limitations
Omission of items that cannot be measured reliably Alternative accounting methods Judgment involved in income measurement

5
Revenues Inflows or other increases in assets or settlement of liabilities related to the entitys ongoing or central operations.

Sales Fee revenue Rent revenue Dividend revenue Interest revenue

6
Expenses Outflows or other decreases in assets or increases in liabilities related to an entitys ongoing or central operations.

Depreciation expense Cost of goods sold Salary expense Insurance expense Interest Expense Rent Expense

7
Gains Increases in assets or decreases in liabilities related to peripheral transactions. Losses - Decreases in assets or increases in liabilities related to peripheral transactions.

Write-off of assets Sale of plant assets or investments

8

Revenues -Expenses Net Income
No distinction between operating and non-operating items.
K,W,W,13th ppt 4-11
Income Statement (in thousands) Revenues: Sales Interest revenue Total revenue Expenses: Cost of goods sold Selling expense Administrative expense Interest expense Income tax expense Total expenses Net income Earnings per share $ 285,000 17,000 302,000 149,000 10,000 43,000 21,000 24,000 247,000 $ 55,000 $ 0.75
Multi-Step Income Statement

9
Separates operating transactions from nonoperating transactions Highlights intermediate components of income Income Statement Sections

Operating Non-operating Income tax Discontinued operations Extraordinary items Earnings per share
Multi-Step Income Statement

10
Income Statement (in thousands) Sales Cost of goods sold Gross profit Operating expenses: $ 285,000 149,000 136,000 10,000 43,000 53,000 83,000 17,000 (21,000) (4,000) 79,000 24,000 $ 55,000
$ 0.75
,w, 1. Operating Section
Selling expenses Administrative expenses Total operating expense Income from operations Other revenue (expense): Interest revenue Interest expense Total other Income before taxes Income tax expense Net income
Earnings per share
2. Nonoperating Section 3. Income tax

K,W,W, 13th, ppt. 4-17

11
Irregular Items unusual items that affect current or past earnings. There is specific FASB guidance on the reporting of these items

Discontinued Operations Extraordinary items Unusual gains and losses Changes in accounting estimates Changes in accounting principles Correction of errors
Discontinued Operations
12
Discontinued operations material gains and losses due to the disposition of a segment of a business . It is considered discontinued by
Eliminating the results of operations and cash flows of the segment, and Discontinuing any significant involvement in the segment After Income from Continuing Operations Net of tax effects Gain or loss from operations separate from disposal
Reporting of discontinued operations


13
Illustration: KC Corporation had after tax income from continuing operations of $55,000,000 in 2008. During 2008, it disposed of its restaurant division at a pretax loss of $270,000. Prior to disposal, the division operated at a pretax loss of $450,000 in 2008. Assume a tax rate of 30%. Prepare a partial income statement for KC. K,W,W 13 ppt 4-23
th
Income from continuing operations Discontinued operations: Loss from operations, net of $135,000 tax Loss on disposal, net of $81,000 tax Total loss on discontinued operations Net income
$55,000,000 315,000 189,000 504,000 $54,496,000

14
Income Statement (in thousands) Sales
Discontinued Operations reported after Income from Continuing Operations
Cost of goods sold

Other revenue (expense): Interest revenue Interest expense Total other Income before taxes Income tax expense Income from continuing operations Discontinued operations: Loss from operations, net of tax Loss on disposal, net of tax Total loss on discontinued operations Net income
$ 285,000 149,000
17,000 (21,000) (4,000) 79,000 24,000 55,000 315 189 504 $ 54,496
K,W,W,13th,
ppt. 4-23
Extraordinary Items
15
Extraordinary items unusual and infrequent material gains and losses, considering the environment the company operates. Example material loss due to earthquake destroying refinery of a multi-national company in a location earthquakes are rare. Reporting
Reported on the income statement after income from continuing operations or discontinued operations if applicable. Reported net-of-tax
Extraordinary Items Example

16
Illustration: KC Corporation had after tax income from continuing operations of $55,000,000 in 2007. In addition, it suffered an unusual and infrequent pretax loss of $770,000 from a volcano eruption. The corporations tax rate is 30%. Prepare a partial income statement for KC Corporation beginning with income from continuing operations.
Income from continuing operations Extraordinary loss, net of $231,000 tax Net income
K,W,W 13th, ppt 4-27
$55,000,000 539,000 $54,461,000
($770,000 x 30% = $231,000 tax)
Extraordinary Items Example

17
Extraordinary Items are reported after Income from continuing operations. (and Discontinued Operation if present)
Income Statement (in thousands) Sales Cost of goods sold
$ 285,000 149,000
Other revenue (expense): Interest revenue Interest expense Total other Income before taxes Income tax expense Income from continuing operations Extraordinary loss, net of tax Net income $ 17,000 (21,000) (4,000) 79,000 24,000 55,000 539 54,461
K,W,W
13th,
ppt 4-29

18
Unusual Gains and Losses material gains and losses that are either unusual or infrequent, but not both. Examples

Inventory write-down Restructuring charges Just before income from continuing operations At gross amount (not net-of-tax)
Reporting

Change in Accounting Principle

19
Change in accounting principle change from one acceptable method to another acceptable method. Examples

Change from FIFO to LIFO for inventory Change from percentage-of-completion to the completed-contract method for accounting for construction costs Retrospective adjustment Cumulative effect adjustment to beginning retained earnings
Reporting

Change in Estimates
20
Change in Estimates many estimates are used in the accounting process. Often new information or a change in circumstances will require a change in an estimate Examples

Change in percentage of bad debts Change in useful lives or salvage values for depreciable assets Handled prospectively (in the period of change and future periods)
Reporting

21
Change in Estimate: Arcadia HS, purchased equipment for $510,000 which was estimated to have a useful life of 10 years with a salvage value of $10,000 at the end of that time. Depreciation has been recorded for 7 years on a straight-line basis. In 2010 (year 8), it is determined that the total estimated life should be 15 years with a salvage value of $5,000 at the end of that time. Questions:
What is the journal entry to correct the prior years depreciation? Calculate the depreciation expense for 2010.
K,W,W 13th ppt 4-36

22
Equipment cost Salvage value Depreciable base Useful life (original) Annual depreciation
$510,000 - 10,000 500,000 10 years $ 50,000
First, establish NBV at date of change in estimate x 7 years = $350,000
Balance Sheet (Dec. 31,2009) Fixed Assets: Equipment Accumulated depreciation Net book value (NBV)
K,W,W 13th, ppt 4-37
$510,000 350,000 $160,000

23
Net book value Salvage value (new) Depreciable basis Useful life remaining Annual depreciation
$160,000 5,000 155,000 8 years $ 19,375
Depreciation Expense calculation for 2010.
Journal entry for 2010 Depreciation expense Accumulated depreciation 19,375 19,375
K,W,W 13th ppt 4-37
Corrections of Errors
24
Corrections of errors due to mistakes or misuse of facts. Examples

Mathematical errors Error in reporting revenue Treated as prior period adjustment Adjust beginning balance in retained earnings
Reporting


25
Intraperiod tax allocation is the allocation of income tax expense for a period to the items that brought about the tax expense. These items are as follows:

Income from continuing operations before tax Discontinued operations Extraordinary items Changes in accounting principles Correction of errors
Example of Intraperiod Tax Allocation

26
Income Statement (in thousands) Sales Cost of goods soldNote:
losses reduce the total Interest expense tax Total other
$ 285,000 149,000
(21,000) (4,000) 79,000 24,000 55,000 315 189 504 54,496 539 $ 53,957
Calculation of Total Tax
Income from cont. oper. before taxes Income tax expense Income from continuing operations Discontinued operations: Loss on operations, net of $135 tax Loss on disposal, net of $61 tax Total loss on discontinued operations Income before extraordinary item Extraordinary loss, net of $231 tax Net income
$24,000 (135) (61) (231) $23,573
K,W,W, 13th ppt 4-44
Earnings Per Share

27
Earnings Per Share is the number of dollars earned per share of common stock. It is a widely accepted business indicator, and it must be disclosed on the income statement.
Net income Preferred Dividends______ Weighted Average of Common Shares Outstanding
Earnings Per Share

28
K,W,W 13th

29
Increases in Retained Earnings

Net income Change in accounting principle Correction of errors
Decreases in Retained Earnings

Net loss Dividends Change in accounting principle Correction of errors

30
Sharp Inc.
Retained Earnings Statement For The Year Ended December 31, 2010
Retained earnings, January 1 Correction for overstating Net Income in prior period Retained earnings, January 1, adjusted Less: Net Loss for 2010 Less: Dividends Retained earnings, December 31 50,000 800,000 (125,000) (25,000) $650,000 $850,000
31
Comprehensive Income represents net income and all gains and losses that bypass net income and affect stockholders equity (other than investments by and distributions to owners)
Unrealized gains and losses on available-for-sale securities Translation gains and losses on foreign currency transactions Pension related And others
Comprehensive Income Formats

32
Second income statement
(Net income +(-) Other Comprehensive Income)
Combined income statement of comprehensive income Part of the statement of stockholders equity
Comprehensive Income Balance Sheet Presentation

33
Accumulated Other Comprehensive Income Disclosed on the balance sheet below retained earnings
K,W,W 13th, Ill 4-21
Uses and Limitations of the Balance Sheet

34
Balance Sheet The financial statement that reports the assets, liabilities, and stockholders equity of an entity at a specific date.
Usefulness Evaluation of capital structure Assess risk and future cash flows Analysis of companys liquidity, solvency, and financial flexibility Limitations Most assets and liabilities reported at historical cost Use of judgments and estimates Omission of items of financial value
Elements of the Balance Sheet

35
Assets Probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events. 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 Residual interest in the assets of an entity that remains after deducting its liabilities. In a business enterprise, the equity is the ownership interest.
Balance Sheet Classifications

36
Assets

Current Assets Long-term investments Property, plant, and equipment Current liabilities Long-term liabilities Capital stock Additional paid-in capital Retained earnings
Liabilities

Owners Equity

Current Assets
37
Current Assets Cash and other assets expected to be converted into cash, sold, or used either in one year or in the operating cycle, whichever is longer.

Cash and cash equivalents Short-term investments

Held-to-maturity Trading Available-for-sale
Receivables Inventories Prepaid expenses
38
Investments in Securities
Stocks, bonds, or long-term notes
Fixed Assets not used in operations Special funds
Pension, plant expansion, cash surrender value of life insurance
Nonconsolidated subsidiaries or affiliated companies

39
Property, Plant and Equipment Tangible, long-lived assets that are used in the regular operations of the business.

Land Buildings Machinery and equipment Capitalized leases Leasehold improvements
Intangible Assets
40
Intangible Assets Operating assets that lack physical substance. Some have a limited life (amortized) while others have an unlimited life (tested for impairment).

Goodwill Trademarks Copyrights Franchises Patents
Current Liabilities
41
Current Liabilities The obligations of the company that can be reasonably expected to be liquidated either through the use of current assets or the creation of other current liabilities.

Accounts payable Accrued compensation Unearned revenue Income tax payable Current maturities of LT debt
Long-Term Liabilities
42
Long-Term Liabilities Obligations that are expected to be liquidated beyond the normal operating cycle or one year, whichever is longer.

Long-term debt Capital lease obligations Deferred income taxes Pension obligations
Owners Equity
43
Capital Stock

Common stock Preferred stock
Additional Paid-in-Capital Retained earnings

Unappropriated Restricted
Treasury Stock
Balance Sheet Example

44
K,W,W 13th Ill 5-16
Balance Sheet Formats

45
Account Form
Report Form
46

Accounting Policies Contingencies Contractual situations Fair values Notes Parenthetical explanations Supporting schedules Cross reference Contra items
Techniques of Disclosure

The Statement of Cash Flows

47
Purpose To provide relevant information about the cash receipts and cash payments of an entity during a period. Content
Operating Cash inflows and outflows from operations Investing Cash inflows and outflows from noncurrent assets Financing Cash inflows and outflows from noncurrent liabilities and equity
The Statement of Cash Flows

48
K,W,W 13th Ill 5-30
Cash Flow Statement Ratios

49
Financial Liquidity
Current Cash Debt = Net Cash Provided by Operating Activities Coverage Ratio Average Current Liabilities
Financial Flexibility
Cash Debt Coverage Ratio = Net Cash Provided by Operating Activities Average Total Liabilities
Free Cash Flow

Free Cash Flow = Net Cash Provided by Operating Activities - Capital Expenditures - Dividends

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Review for Exam 1

Review for Exam 1

Review for Exam 1

Statement of Retained Earnings

Review for Exam 1

Statement of Cash Flows

Review for Exam 1

Prepared by Coby Harmon University of California, Santa Barbara

Financial Accounting and Accounting Standards

Intermediate Accounting 14th Edition

Kieso, Weygandt, and Warfield

Financial Accounting and Accounting Standards

Financial Statements and Financial Reporting

Parties Involved in Standard-Setting

Generally Accepted Accounting Principles

Issues in Financial Reporting

Financial Statements and Financial Reporting

Financial Statements and Financial Reporting

Financial Statements and Financial Reporting

Financial Statements and Financial Reporting

LO 2 Explain how accounting assists in the efficient use of scare resources.

Accounting and Capital Allocation

LO 2 Explain how accounting assists in the efficient use of scare resources.

Financial Statements and Financial Reporting

present and potential equity investors, lenders, and other creditors

in making decisions in their capacity as capital providers.

LO 3 Identify the objectives of financial reporting.

Objective of Financial Accounting

Equity Investors and Creditors

LO 3 Identify the objectives of financial reporting.

Objective of Financial Accounting

Need to Develop Standards

Generally Accepted Accounting Principles (GAAP)

LO 4 Explain the need for accounting standards.

Parties Involved in Standard Setting

Financial Accounting Standards Board (FASB).

Parties Involved in Standard Setting

Established by federal government. Accounting and reporting for public companies.

Securities Act of 1933

Securities Act of 1934

Parties Involved in Standard Setting

National professional organization Established the following:

Committee on Accounting Procedures

Accounting Principles Board

Parties Involved in Standard Setting

Consult on major policy issues.

Financial Accounting Standards Board

Financial Accounting Standards Board Review

Financial Accounting Standards Board

Financial Accounting Standards Board

(d) (f) (c) (e) (a) (b)

Parties Involved in Standard Setting

Audit and Accounting Guides. Statements of Position (SOP). Practice Bulletins.

Generally Accepted Accounting Principles

Generally Accepted Accounting Principles

Generally Accepted Accounting Principles Review

Generally Accepted Accounting Principles

Generally Accepted Accounting Principles

Issues in Financial Reporting

LO 7 Describe the impact of user groups on the rule-making process.

Issues in Financial Reporting

LO 7 Describe the impact of user groups on the rule-making process.

Issues in Financial Reporting