I. The Formulation of Accounting Theory: two crucial questions
A.
B.
II. The Financial Accounting Standards Board
A. Structure of the FASB
FAF
|
| ------|
FASB Financial Accounting Advisory Council
7 members (minimum 20 members)
B. Process
1. task force
2. discussion memo
3. public hearings
4. staff analysis of 2 and 3
5. board meeting
6. preliminary views
7. exposure draft
8. issuance of standards
C. Objectives of FASB
1. improve usefulness of financial statements (F/S)
2. provide up-to-date standards
3. consider problems promptly
4. improve understandability of what F/S represent
III. Guidelines for FASB
A. neutral information
B. listen to constituents
C. weigh cost/benefits
D. minimize disruption of continuity
E. review past decisions
IV. Politicization of Accounting
A. Accounting information affects economic behavior
1.
2.
3.
B. Examples of 1, 2, & 3
1. Postretirement Benefits
2. Research and Development
3. Stock-based compensation
V. Statement of Financial Accounting Concept #1: "Objectives of Financial Accounting by Business Enterprises"
A. Purpose of financial reporting
1. provide useful information
2. recognize that accounting is not immutable
3. limitations and qualifications
a. uses approximate measures
b. report on historical events
c. one of many other sources of information
d. costly
B. Objectives of financial reporting: provide information to investors and creditors on the amount, timing, and uncertainty, of future cash flows and
1. economic resources
2. claims on those resources
3. changes in 1 and 2
VI. SFAC #2: "Qualitative Characteristics of Accounting Information":
Cost/Benefit
USEFULNESS
Understandability
Relevant Reliable
Timely Predictive Feedback Verifiable Neutral Rep. Faithful
value value
Comparable Consistent
Materiality
MC. Reporting inventory at the lower of cost or market is a departure from the accounting principle of
a. Historical cost.
b. Consistency.
c. Conservatism.
d. Full disclosure.
VII. Cash versus Accrual Accounting: Cash basis accounting measures income as difference between cash in and cash out. Accrual basis accounting measures revenues when earned and matches expenses with the revenues they generate (e.g., depreciation). For example, Mr. Bart S. owns a hardware store:
1. Bart contributes $10,000 in cash and borrows $10,000 more at 12% interest
2. Bart prepays 2 months rent at $1,000 month
3. Bart prepays 1 year's insurance of $1,200
4. Bart buys $20,000 of inventory for $13,000 in cash and a $7,000 A/P.
5. Bart sells inventory that cost him $16,000 for $25,000 ($17,000 in cash and $8,000 in A/R)
6. Bart owes his employees $2,500
Monthly Cash Income Statement
Cash Receipts from Sales $17,000
Cash paid:
Inventory 13,000
Rent 2,000
Insurance 1,200 16,200
Net Income 800
Monthly Accrual Basis Income Statement
Sales $25,000
Cost of goods sold 16,000
Gross Margin 9,000
Operating expenses
Salaries 2,500
Rent* 1,000
Insurance** 100 3,600
Income from operations 5,400
Other revenues/expenses
Interest*** 100
Net Income 5,300
* $2,000/2 months
** $1,200/12 months
*** $10,000 x 12% x 1/12
MC. For $50 a month, Rawl Co. visits its customers' premises and performs insect control services. If customers experience problems between regularly scheduled visits, Rawl makes service calls at no additional charge. Instead of paying monthly, customers may pay an annual fee of $540 in advance. For a customer who pays the annual fee in advance, Rawl should recognize the related revenue
a. When the cash is collected.
b. At the end of the fiscal year.
c. At the end of the contract year after all of the services have been performed.
d. Evenly over the contract year as the services are performed.
MC. Compared with the accrual basis of accounting, the cash basis of accounting understates income by the net decrease during the accounting period of
Accounts
Receivable Accrued Expenses
a. Yes Yes
b. Yes No
c. No No
d. No Yes
Accrual Basis
Receivables?
Accrual Basis
Cash Basis
Before 1991, Adroit Co. used the cash basis of accounting. As of December 31, 1991, Adroit changed to the accrual-basis. Adroit cannot determine the beginning balance of supplies inventory. What is the effect of Adroit's inability to determine beginning supplies inventory on its 1991 accrual-basis net income and December 31, 1991 accrual-basis owners' equity?
1991 Net Income 12/31/91 Owners' Equity
a. No effect No effect
b. No effect Overstated
c. Overstated No effect
d. Overstated Overstated
VIII. Real versus Nominal Accounts
A. Real accounts: Balance carries over from 1 accounting period to the next
1.
2.
3.
B. Nominal accounts: temporary accounts used to measure net income for the current accounting period. Nominal accounts are "closed" to a zero balance at the end of each period.
Example: We earn $100 in revenue on December 26 for accounting services for and incur $20 in cost.
Entries:
12/26/01
(a) A/R 100
Revenue 100
(b) Expense 20
A/P 20
12/31/01
(c) Revenue 100
Income Summary 100
(d) Income Summary 20
Expense 20
(e) Income Summary 80
Capital 80
A/R A/P Revenue
(a) 100 | | 20 (b) |100 (a)
| | (c)100 |
| | |
I/S Capital Expense
|100 (c) | (b) 20|
(d) 20 | | 80 (e) | 20 (d)
(e) 80 | | |
MC. The changes in account balances of the Vel Corporation during 1995 are presented below:
Increase
Assets $356,000
Liabilities $108,000
Capital stock $240,000
Additional paid-in capital $ 24,000
Assuming there are no charges to retained earnings other than for a dividend payment of $52,000, the net income for 1995 should be
a. $16,000
b. $36,000
c. $52,000
d. $68,000
If the other owners’ equity accounts increased by $264,000, then retained earnings must have decreased by $16,000 net.
Retained Earnings
dividends 52,000 | 36,000 net income
IX. 3 major considerations in determining net income
A. Going concern (continuity): firm will continue to exist indefinitely.
B. Annual accounting period (periodicity): users of accounting want information for an arbitrary period
C. Historical cost: Assets and liabilities are recorded and presented on the financial statements at the original acquisition cost.
MC. On December 31, 1994, KMM Co. decided to end operations and dispose of its assets within 3 months. At December 31, 1994, the net realizable value of the equipment was below historical cost. What is the appropriate measurement basis for equipment included in KMM's December 31, 1994 balance sheet?
a. Historical cost.
b. Current reproduction cost.
c. Net realizable value.
d. Current replacement cost.
X. Accrual accounting: Revenue recognized when earned (i.e., sale of goods or performance of services) and expenses matched (allocated to time period) revenues earned.
How? 4 types of adjusting entries
1. Revenues recorded, not yet earned (deferred)
2. Revenues earned, not yet recorded (accrued)
3. Expenses recorded, not yet incurred (deferred)
4. Expenses incurred, not yet recorded (accrued)
Examples:
1. On Jan. 1, we collect 2 months rent in advance at $600 a month ($1,200 total).
Entries
Cash R.C.I.A. Revenue
1,200| | | 1200
| | 600 600 |
| | |
2. We are owed $600 rent for January but are not paid until Feb. 2
Entries
3. We owe 1 month's rent for January but prepay 2 months' rent on Jan. 1
Entries
4. We owe one month's rent on Jan. 31 but do not pay until Feb. 2.
XI. Preparing an Adjusted Trial Balance (ATB)
A. Accounting Cycle
1. Journalize in the general and 4 special purpose journals
2. Post to the ledger
3. Prepare a trial balance
4. Make adjusting entries
5. Prepare an ATB
6. Close all nominal accounts
7. Prepare a post-closing Trial Balance.
8. Reverse
B. Example of an ATB: Assume the following information has been provided: ABC Corp. has $10,000 in cash, $5,000 in accounts receivable, $2,400 in Prepaid Insurance (a three year policy), $50,000 in Equipment, $20,000 in Accounts Payable, $10,000 in Unearned Revenue, and $37,400 in Capital.
C. Prepare a Trial Balance.
D. Assume the following additional data:
1. ABC owes $3,000 in salaries
2. The equipment has an estimated life of 10 years, no salvage value, and is depreciated using the straight-line method.
3. One-third of the insurance has expired.
4. $9,000 of the unearned revenue has been earned.
E. Prepare the necessary adjusting entries
(1)
Salary expense 3,000
Salary payable 3,000
(2)
Depreciation expense 5,000
Accumulated depreciation 5,000
(3)
Insurance Expense 800
Prepaid Insurance 800
(4)
Unearned Revenue 9,000
Revenue 9,000
F. Prepare an ATB