Popular in Organization and Management Leadership iCourse
verified elite notetaker
Popular in Department
This 10 page Class Notes was uploaded by Linsey Moen on Monday September 19, 2016. The Class Notes belongs to MGT 300 at Arizona State University taught by Dr. David Kim McKinnon in Fall 2016. Since its upload, it has received 4 views.
Reviews for Practice Upload
Report this Material
What is Karma?
Karma is the currency of StudySoup.
Date Created: 09/19/16
CH 2 Conceptual Framework FASB’s conceptual framework serves as a foundation for giving you insights into the “what”, “why” and “how” of understanding financial statement elements and disclosures Conceptual Framework – Statements of Financial Accounting Concepts (SFAC) Broad concepts that are intended to establish useful & consistent standards. (The Concept Statements are NOT authoritative GAAP.) This framework is used by FASB: To develop a coherent set of standards and rules. To solve new and emerging practical problems. To prescribe the nature, function, and limits of financial accounting and financial statements. The “Conceptual Framework” consists of (8) concept statements. Provide users with the ability to: 1) Assess the amount timing and uncertainty of future cash flows 2) Asses the company’s assets, lib and equity I. Understanding the Terminology Used in the Conceptual Framework A. QUALITATIVE CHARACTERISTICS – Distinguishes between “more useful” and “inferior” information. 1. “Primary” Qualities (what makes the info useful): Relevance: by knowing the information, it is capable of making a difference to the decision maker. Why we use Predictive Value – more likely to correctly forecast future results “comparative” Confirmatory Value (Feedback Value) – confirm or correct prior expectations. statements Materiality – if by omitting or misstating the information, it would influence the decisions of the user. (deciding if something is an asset or an expense) Faithful Representation: the info must faithfully represent the events that actually happened (substance over form.) all information is ethically correct Complete disclose all info necessary to understand the true economic impact of the event. Neutral – without bias. (Not weighted, emphasized, deemphasized, etc. to favor one party or another.) Free from Error – Does NOT mean perfectly accurate; describe the process & limitations for using estimates & no errors in “the process” of “using the best available information” 2. Enhancing Qualitative Characteristics: Comparability – ability to compare with similar information reported by other entities and by the same entity across time periods. (Yr 1 – Yr 2 – Yr 3). This quality includes consistency. Verifiability – two independent parties using the same information would come to the same conclusions…therefore it can be relied on Timeliness – must report the information in a timely manner before it loses its value. Understandability – understandable to users with reasonable financial knowledge & willingness to study the information. II. SFAC #6 – UNDERSTANDING THE BASIC ELEMENTS Concept #6 defines the 10 elements that are directly related to measuring the performance and financial position of a company. A. Statement of Financial Position – reported at a point in time a. ITEMS ON THE BALANCE SHEET 1. Assets – resources owned by or owed to the entity that will generate “probable” future economic benefits. 2. Liabilities – probable future sacrifices to settle an obligation from past transactions. Debt that the company owes 3. Equity – the residual claims of owners. B. Earnings for the Period – reported over a period of time ITEMS ON THE INCOME STATEMENT 4. Revenues – inflows of assets (cash or A/R), or the settlement of liabilities (unearned revenue) as a result of performing services/delivering goods from ongoing operations . 5. Expenses – outflows of resources (expired costs) as a result of ongoing operations. 6. Gains Increases/decreases in equity due to incidental transactions 7. Losses C. Investments & Distributions to Owners – reported over a period of time 8. Investments by Owners – increases in equity due to original investment by owners. 9. Distributions to Owners – decreases in equity due to dividends. D. Comprehensive Income – reported over a period of time ABC Inc. invests in 1,000 shares of IBM stock @ $10/share on Oct. 1 , 15’ and 10. Comprehensive Income – all other changes in equity except those intends to hold for long term. At Dec. 31, 2015 IBM stock is trading resulting from Investments by Owners (#8 above) and Distributions to Owners (#9 above). = NET INCOME OF CURRENT YEAR +/ OCI $15/share. Orig Cost = $10,000 Includes Net Income of current year and (4) “Other Comprehensive Fair Value = $15,000 DEC 31 BALANCE SHEET Income” items (OCI): Assets 1) “ Unrealized” (Holding) Gains/Losses from AFS(Available for Sale Invest – AFS $10,000 DR Securities)stocks and bonds +Fair Value Adj. $5,000 DR Invest @ Fair Value $15,000 DR 2) Translation Adjustments on Foreign Currency Adj Entry: DR Fair Value Adj: 5,000 CR “Unreal” Gain AFS 5,000 3) Pension Liability Adjustments 4) Unrealized Gains/Losses from Hedging Transactions III. SFAC #5 ASSUMPTIONS, PRINCIPLES & CONSTRAINTS Sets forth recognition & measurement criteria on what should be contained in financial Deferral: Unearned Rev. statements. (Includes Assumptions, Principles & Constraints) Any kind of prepayment. A. Assumptions: 1. Economic Entity Assumption – the owner and the business are separate & distinct entities. Furthermore, it means that all economic activities of an entity can be identified with one accountable unit (i.e. the Parent Company is responsible for reporting the aggregated results of all of its subsidiaries) Consolidated Income Stmnt: Income Statement from all subsidiaries 2. Going Concern Assumption the company will continue to operate into the foreseeable future. If we are a “Going Concern” we report a “Classified” Bal. Sheet (Current Assets and LongTerm Assets; CL < Debt). Report Plant, Property and Equip at Historical cost, NOT fair value or liquidation value. Report PP&E at Book Value(BV)=Original Cost – Accum Dep. 3. Monetary Unit Assumption financial statements are reported in the U.S. Dollar and the dollar is considered to be stable 4. Periodicity (Time Period) Assumption – a company must report their results before the information loses its value (i.e. quarterly, annually) Example: For each situation, explain which underlying assumption supports this accounting practice. a. Consolidating financial statements from several divisions of a parent company to create the 10K Report: Economic Entity Assumption ____________________________________________ b. ABC Company reports fixed assets at historical cost and depreciates them: Going Concern Assumption _____________________________________________ B. (4) Principles: 1. Measurement Principle – (2) most common measurements are based on Historical Cost or Fair Value. Therefore, this is called a “mixed attribute” model a. Historical Cost – report assets/liabilities based on the original acquisition cost. (Things such as PP&E because there’s no intent of selling and we want the most accurate and not subjective assessment of cost) Advantage – Objective, reliable, and Verifiable b. Fair Value – the current cash equivalent value. (i.e. What a willing party would pay TODAY as of the balance sheet date.) The price that would be received to sell an asset or paid to transfer a liability on the measurement date Advantage RELEVANT but can be more subjective With the increased use of Fair Value, FASB has introduced a Fair Value Hierarchy to increase consistency & transparency of objectivity/subjectivity. Must disclose what level you used to come up with the Fair Value Most Reliable Level I Observable inputs, quoted market prices for identical units, active markets. Level II – Observable inputs other than quoted market prices Most UnreliableLevel III – Unobservable inputs. Relies on company’s own data or assumptions. However, that does not mean that all assets and liabilities are on the books at historical cost or Fair Value. To maximize relevance & representational faithfulness, some modifications are required. U.S. GAAP uses a “Mixed Attribute” model. A/R $100,000 Examples of “Mixed Attribute” measurements: () Allow (2,000) A/R Report @ Net Realizable Value (NRV) Doubt Acct Apple sells iPhone for 600. 2. Revenue Recognition Principle – states when revenue should be recognized. The timing Apple promises to provide of when revenue is recognized is a key element to correctly measuring income. two years of software When a company agrees to perform a service or sell a product to a customer, it has a updates. performance obligation. When the company satisfies the performance obligation (i.e. Apple determines that 80% of their costs is associated delivers the goods or performs the service), it recognizes revenue. The Revenue with the phone. 20% Recognition Principle requires companies to recognize revenue in the accounting period Associated with the in which the performance obligation is satisfied. software. Point of sale Over time as goods delivered/service performed 2017 New Standard on Revenue Recognition (as of May 28, 2014; Effective after Dec 15, 2016): In applying the new Revenue Recognition model, an entity would: 1. Identify the contract with a customer. willing buyer 2. Identify the separate performance obligations in the contract. (2. Provide phone and provide software) 3. Determine the transaction price. 600 4. Allocate the transaction price to the separate performance obligations in the contract. Phone – 80%(600) = $480 Recognized at sale Software – 20%(600) = $120 / 24 (because software updates go on for 2 years) = $5/month 5. Recognize revenue when each performance obligation is satisfied 3. Expense Recognition Principle (Matching Concept) match revenues earned with expenses incurred in same time period the expense helped to generate the revenue. Determines to how we measure earnings and the timing of asset and liability recognition. Direct Matching Assumes cause/effect relationship. (i.e. product costs COGS) Sales commission, things w/ a direct correlation Indirect Matching applies a systematic & rational allocation of cost to expense (i.e. Depreciation Expense) Straight – line depreciation Immediate Recognition – some costs are incurred, but impossible to determine in which period, if any, related revenues will occur. Therefore expense in period incurred (i.e. period costs such as advertising expense, research & development exp) Example: On Jan. 21, Sparky Electronics sells a 72” HD TV to a customer for $3,500 on account. The goods were delivered at the point of sale. The TV cost Sparky $1,000 when they purchased it from their supplier. Sparky will pay a 2% sales commission next month to the salesperson who assisted the customer. Sparky depreciates their building and fixtures at a rate of $700 per month. Additionally, for the month of January, Sparky incurred $500 for utilities. Income Statement For the month ended January 31, 2016 Revenue: $3,500 Direct Matching (-)COGS: ($1,000) Direct Matching (-)Sales Commission ($70) Direct Matching (-) Dep. Exp. ($700) Indirect Matching (-) Utilities ($500) Immediate Recognition 4. Full Disclosure Principle – Simple set of foot notes explaining how you derived with the cost that you reported. Such as if you use historical cost, or fair value. C. Constraints: Cost Constraint Providing useful financial information is limited by a pervasive constraint on financial reporting – “cost” should not exceed the “benefits” of a reporting practice. *Industry Practice – exceptions to the basic rules for reporting financial information because of unique circumstances in the industry as a whole.