NINJA Book FAR 1 Conceptual Framework PDF

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NINJA BOOK F I N A N C I A L AC C O U N T I N G A N D R E P O R T I N G I 2 018 C O N C E P T UA L F R A M E WO R K & F I N A N C I A L S TAT E M E N T P R E S E N TAT I O N COPYRIGHT This book contains material copyrighted © 1953 through 2018 by the American Institute of Certified Pub- lic Acco...

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NINJA BOOK F I N A N C I A L AC C O U N T I N G A N D R E P O R T I N G I

2 018

C O N C E P T UA L F R A M E WO R K & F I N A N C I A L S TAT E M E N T P R E S E N TAT I O N

COPYRIGHT

This book contains material copyrighted © 1953 through 2018 by the American Institute of Certified Public Accountants, Inc., and is used or adapted with permission. Paragraphs from the FASB Accounting Standards Codification® and portions of various FASB and GASB documents are copyrighted by the Financial Accounting Foundation, 401 Merritt 7, P.O. Box 5116, Norwalk, CT 06856-5116, and are reprinted with permission. Complete copies of these documents are available from the Financial Accounting Foundation. Material from the Uniform CPA Examination Questions and Unofficial Answers, copyright © 1976 through 2018, American Institute of Certified Public Accountants, Inc., is used or adapted with permission. This book is written to provide accurate and authoritative information concerning the covered topics. It is not meant to take the place of professional advice in any way. © 2018 NINJA CPA Review, LLC. All Rights Reserved. i

I

ACCOUNTING STANDARDS

2

A.

U.S. Securities and Exchange Commission (SEC)

01 The SEC is a governmental entity created to protect the interest of investors by ensuring full and adequate disclosure by publicly traded companies. Although the SEC has the authority to establish standards, it has generally deferred to the Financial Accounting Standards Board (FASB) or its predecessors to generate U.S. accounting standards. Application: What types of rules are generally issued by the SEC? The SEC issues Financial Reporting Releases that usually agree with U.S. GAAP. The SEC issues U.S. GAAP. The SEC does not issue rules. None of the answer choices are correct. A - The Securities and Exchange Commission (SEC) is a governmental entity created to protect the interest of investors by ensuring full and adequate disclosure by publicly traded companies. Although the SEC has the authority to establish standards, it has generally deferred to the Financial Accounting Standards Board (FASB) or its predecessors to generate U.S. accounting standards. The SEC does issue its own rules in the form of Financial Reporting Releases, which generally agree with U.S. GAAP. 02

The SEC rule-making process can involve several steps: concept release, rule proposal, and rule adoption.

Concept Release: The rule-making process usually begins with a rule proposal, but sometimes an issue is so unique and/or complicated that the Commission seeks out public input on which, if any, regulatory approach is appropriate. Rule Proposal: The Commission publishes a detailed formal rule proposal for public comment. Rule Adoption: Finally, the Commissioners consider what they have learned from the public exposure of the proposed rule, and seek to agree on the specifics of a final rule. The SEC issues its own rules in the form of Financial Reporting Releases, which generally agree with U.S. GAAP Application: The Securities and Exchange Commission was created under which of the following acts? The 1933 Securities Act The 1934 Securities Exchange Act The Tax Equity and Fiscal Responsibility Act Both the 1933 Securities Act and 1934 Securities Exchange Act B - The 1934 Securities Exchange Act created the Securities and Exchange Commission (SEC).

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B.

Financial Accounting Standards Board (FASB)

01 Basic accounting principles or standards, commonly referred to as generally accepted accounting principles (GAAP), represent the most authoritative position at any point in time as to which economic resources and obligations should be recognized in financial statements as assets and liabilities, which changes in those assets and liabilities should be recognized, when those changes should be recognized, how those recognized changes should be measured, what information should be disclosed and how that information should be disclosed, and which financial statements should be prepared. Application: Generally accepted accounting principles are: pronouncements of the Financial Accounting Standards Board. the basic concepts underlying financial accounting and reporting. guidelines that accountants may choose to follow. established principles that rarely change. B - Generally accepted accounting principles (GAAP) are the basic concepts underlying financial accounting and reporting that have substantial authoritative support. GAAP includes pronouncements of other authoritative bodies, such as the Accounting Principles Board, Governmental Accounting Standards Board, Securities and Exchange Commission, and the American Institute of Certified Public Accountants boards and committees, in addition to pronouncements of the Financial Accounting Standards Board and the FASB's Accounting Standards Codification. GAAP also includes specific practices that have widespread use and are included in accounting textbooks and other writings. GAAP is more than just guidelines. Accountants are required by Rule 203 of the code of professional conduct to follow GAAP except in those limited situations in which unusual circumstances would cause financial statements prepared in accordance with GAAP to be misleading; following GAAP is not a choice left to the discretion of the practitioner. GAAP incorporates a consensus that spurs an evolutionary process, so that these principles continuously change over time in response to changes in economic, legal, political, and social conditions; new knowledge and technology; and demands of users for more useful information.

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02

Review of Underlying Accounting Principles Principle

Explanation

Application

Historical Cost

As a measurement basis, historical cost is the most objectively determinable and is the proper basis for the recording of many asset acquisitions, expenses, costs, creditor equities, and owner equities.

Plant assets are recorded at their historical cost and not current replacement value or some other basis in the primary financial statements.

Revenue Recognition

Revenue is recognized when it is earned, measurable, and collectible. At this point, the earnings process is virtually complete. Although recognition through sale is the most consistently used test, circumstances may allow recognition at other points in the earning cycle.

Accrual accounting recognizes revenue at the point of sale and is generally accepted as opposed to the cash basis of accounting which records revenues in the period during which cash is received.

Matching

Net Income or loss for an accounting period is determined by the process of associating realized revenues with those expenses and expired costs necessary to generate them. This often requires estimates and allocations.

The accrual basis of accounting correctly matches the revenue from the sale of goods with the historical cost of the inventory sold, the salesperson’s salary, and other applicable costs and expenses.

Consistency

To enhance financial statement comparability, an entity employs the same accounting procedures from period to period. Changes within GAAP should be justified by more appropriate presentation of financial position and results of operations.

The LIFO inventory method, once adopted, is applied in following years.

Disclosure

Financial statements should include all information germane to the formation of valid business decisions. The user must neither be burdened with an information overload nor misled by the exclusion of material facts.

Notes to the financial statements are a common form of supplementary disclosure.

Objectivity/ Verifiability

The economic activity which underlies financial statements must not only be substantive in fact but also presented without bias so as to be subject to similar determination by other technically competent individuals.

Plant assets are carried at cost, which is generally definite and determinable, and not at net present value based on subjective judgments.

Separate Entity

A business enterprise is a discrete unit of accountability whose economic activities are kept separate from those of its owners and other business enterprises.

Personal business transactions of a major stockholder are not reported in the financial statements of a corporation.

Continuity/ Going Concern

However, in connection with preparing financial statements, management must evaluate whether there are conditions and events that raise substantial doubt about an entity’s ability to continue as a going concern.

Liquidation values of assets and liabilities are ordinarily not used in preparing a company’s Balance Sheet.

Unit of Measure

The common denominator upon which all financial data are based is the monetary unit. Further, it is assumed that the monetary unit remains stable in value (or changes are immaterial in amount) so that the impact of real changes in its purchasing power remain unadjusted-for in the primary financial statements.

The economic activity of a U.S. business enterprise is quantified in terms of the dollar. Inflationary trends are not reflected in the primary financial statements by adjustments to non-monetary items.

The life of an enterprise is divided into artificial time periods to facilitate reporting and decision making.

Although the success or failure of an enterprise is subject to the most accurate determination when the enterprise discontinues operations, financial statements are prepared annually.

Periodicity

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Application: Reporting inventory at the lower of cost or market is a departure from the accounting principle of: historical cost. consistency. conservatism. full disclosure. A - Financial accounting is primarily based on the historical cost principle which specifies that assets be recorded and carried at their historical acquisition cost. When reporting inventory at the lower of cost or market, cost is compared with market (usually some variant of replacement cost) and the lower value is used to reflect the loss of utility (i.e., market value) of the goods. Selection and use of a value other than acquisition cost is clearly a departure from the historical cost principle.

03 Modifying Conventions - These represent conceptual explanations for a departure from what might otherwise be thought of as generally accepted. Modifying Convention

Explanation

Application

Conservatism

When confronted with alternative accounting procedures, the accountant follows that which has the least favorable impact on current income.

Losses may be anticipated while gains are normally not recognized in the accounts until they are realized.

Industry practices.

Departure from strict compliance with GAAP may exist in some cases due to the peculiar nature of the industry in which an enterprise operates.

Due primarily to allocation problems, the companies in the meat packing industry carry inventory at selling prices less costs of disposal, a departure from the principle of historical cost.

Substance over Form

The economic substance of a transaction determines the accounting treatment, even though the legal form of the transaction may indicate a different treatment.

Under certain circumstances, leased property may be capitalized as a sale (by the lessor) and as an acquisition (by the lessee).

Application of Judgement

In some cases, strict adherence to GAAP produces results that are unreasonable. A departure from GAAP may be made to render results that appear reasonable in the circumstances.

Disclosure of events which is not required by authoritative pronouncements may be considered necessary in specific circumstances by individual accountant(s) responsible for the content of financial statements.

Materiality

The accounting treatment of many items is dependent upon their resultant impact on users’ decisions. Strict compliance with GAAP is necessary only when an item, due to its dollar size and/or nature, has a significant effect on financial statements and the accompanying investor decisions.

The purchase price of inexpensive long-lived assets might be expensed (rather than being capitalized and depreciated over their useful lives) if the dollar amounts involved are so small as to be insignificant.

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04 Accounting Standards Codification - Effective for financial statements issued for interim and annual periods ending after September 15, 2009, the Accounting Standards Codification is the single source of authoritative GAAP recognized by the FASB to be applied by nongovernmental entities. Rules and interpretive releases of the SEC under federal securities laws are also sources of authoritative GAAP for SEC registrants. All guidance contained in the Codification carries an equal level of authority. 05

Non-authoritative accounting guidance and literature that include:

a.

practices that are widely recognized and prevalent either generally or in the industry

b.

FASB Concepts Statements

c.

American Institute of Certified Public Accountants (AICPA) Issues Papers

d.

International Financial Reporting Standards of the International Accounting Standards Board (IASB)

e.

pronouncements of professional associations or regulatory agencies

f.

Technical Information Service Inquiries and replies included in AICPA Technical Practice Aids

g.

accounting textbooks, handbooks, and articles

Application: Arpco, Inc., a for-profit provider of healthcare services, recently purchased two smaller companies and is researching accounting issues arising from the two business combinations. Which of the following accounting pronouncements are the most authoritative? AICPA Statements of Position FASB Accounting Standards Codification FASB Statements of Financial Accounting Concepts FASB Statements of Financial Accounting Standards B - Under FASB ASC 105-10-15-1, effective for financial statements issued for interim and annual periods ending after September 15, 2009, the Accounting Standards Codification (ASC) is the single source of authoritative GAAP recognized by the FASB to be applied by nongovernmental entities. Rules and interpretive releases of the SEC under federal securities laws are also sources of authoritative GAAP for SEC registrants. All guidance contained in the Codification carries an equal level of authority.

7

06 The FASB is currently the body responsible for developing accounting standards in the United States. The FASB’s primary functions are to study current issues and generate new accounting standards. 07 Accounting Standards Updates issued after September 2009 will not be considered authoritative in their own right. Instead, the Accounting Standards Updates will serve only to update the Accounting Standards Codification, provide background information about the guidance, and provide the Basis for conclusions on the change(s) in the Codification. Application: Which of the following statements best describes an operating procedure for issuing a new Financial Accounting Standards Board (FASB) Accounting Standards Update? The emerging issues task force must approve a discussion memorandum before it is disseminated to the public. The exposure draft is modified per public opinion before issuing the discussion memorandum. An update is issued only after a majority vote by the members of the FASB. A new FASB update can be rescinded by a majority vote of the AICPA membership. C - The Board issues an Accounting Standards Update by simple majority vote. Accounting Standards Updates issued after September 2009 will not be considered authoritative in their own right. Instead, the Accounting Standards Updates will serve only to update the Accounting Standards Codification, provide background information about the guidance, and provide the Basis for conclusions on the change(s) in the Codification.

8

II

CONCEPTUAL FRAMEWORK

9

A.

Financial Reporting by Business Entities

01 Objective of Financial Reporting - General financial reporting should provide information that is useful to present and potential investors, lenders, and other creditors in making rational decisions about providing resources to the entity. These decisions involve buying, selling, or holding equity and debt instruments and providing or settling loans and other forms of credit. Other parties are not the primary users but may also use general purpose financial reports. a. Primary users of general purpose financial statements are existing and potential investors, lenders, and other creditors. These users make decisions about buying, selling, or holding equity and debt instruments or providing credit by evaluating the expected returns from their investment. These parties need information about the prospects of future net cash inflows to the entity. They also need information about the entity’s resources, claims against those resources, and how efficiently the entity’s management and governing board have used the entity’s resources. b.

Financial statements are, to a large extent, based on estimates, judgments, and models.

c. Current cash flow information helps users to assess an entity’s ability to generate cash flows in the future. It does this by providing information about how the entity generates cash flows. Application: During a period when an enterprise is under the direction of a particular management, its financial statements will directly provide information about: both enterprise performance and management performance. management performance but not directly provide information about enterprise performance. enterprise performance but not directly provide information about management performance. neither enterprise performance nor management performance. C - Financial statements provide direct information about enterprise performance because the primary focus of the statements is to provide information about the financial performance of that enterprise by providing information about earnings. The same cannot be said, however, in regard to management performance. The financial statements depict only indirect information concerning management performance. (Direct information related to management performance would be provided in internal managerial performance reports but not in the external financial statements.) 02

Primary Qualitative Characteristics: Relevance and Faithful Representation

a. Relevance: To be relevant to investors, creditors, and other users, accounting information must be capable of making a difference in a decision. Financial information is capable of making a difference if it has predictive value, confirmatory value, or both. It must also be material. 1.

Predictive Value: Financial information has predictive value if it can be used as an input to processes employed by users to predict future outcomes.

2. Confirmatory Value: Financial information has confirmatory value if it provides feedback about (confirms or changes) previous evaluations. 3. Materiality: Financial information is material if omitting it or misstating it could influence decisions that users make on the basis of the financial information of a specific reporting entity.

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Application: Which of the following characteristics of accounting information primarily allows users of financial stateme...