written by
J. Russell Madray, CPA, CIA, CMA, CFM
Ralph J. Byington, PhD, CPA
Course Information
Prerequisite |
A familiarity of this particular topic |
Field of Study |
Accounting |
CPE Credit Hours |
10 |
Author Biography
J. Russell Madray, CPA, CIA, CMA, CFM, is a nationally-known accounting and auditing thought leader, writer, and advisor, with more than 30 years of professional experience, including stints at two Big 4 accounting firms, helping CPAs throughout the country understand and implement technical accounting and auditing issues. Mr. Madray is a Senior Lecturer in the School of Accountancy at Clemson University, one of the most selective public research universities. As an author, Russ is responsible for several of the professional publications and is a frequent contributor to the Journal of Accountancy. Mr. Madray earned a B.S. in Accounting from Clemson University in 1986 and a Master of Professional Accountancy from Clemson University in 1988. He is a certified public accountant, a certified global management accountant, a certified internal auditor, a certified management accountant, and a certified financial manager. He is a past member of the AICPA Accounting and Review Services Committee and has served on several other AICPA and state-level committees and boards.
Ralph J. Byington, PhD, CPA, is a Professor of Accounting at Coastal Carolina University. Dr. Byington has held the positions of Interim Dean and Associate Dean at other universities. Additionally, he was the founding Director of the School of Accountancy at Georgia Southern University. With over 18 years of administrative experience at four universities, he has helped foster student achievement, faculty development, and community involvement. He is active with the accounting profession, presenting numerous professional programs at the national, regional, and local level. His publications include over one hundred journal articles, book chapters, newsletter items, and proceedings. At the 1996 national meeting of the American Accounting Association, he and a co-author received the Notable Contributions to the Information Systems/ Management Advisory Services Literature Award. In 1995, he received the Southwest Federation of Administrative Disciplines Distinguished Paper Award in the accounting area.
Course Description
This course begins by giving users a refresher course in the basics of financial accounting and reporting. It includes a review of accounting principles and the purposes and formats of the major financial statements. The program proceeds to go down and through the balance sheet and devote separate chapters to each of the major balance sheet account classifications. For example, on the asset side, inventory is covered in chapter three, and, on the liabilities side, bonds are extensively discussed in chapter six. Separate chapters have been reserved for both leases and pension plans. This basic level course is most beneficial to professionals new to this topic who may be at the staff or entry level in an organization but also for a seasoned professional with limited exposure to this topic.
Learning Objectives
Upon successful completion of this course, the user should be able to:
recognize the formats and elements of balance sheets and income statements,
determine the valuation of accounts receivable and methods of recognizing uncollectible receivables,
identify the different methods for measuring inventories,
recognize the accounting requirements for the various ways of acquiring fixed assets, cost recovery, impairment, and disposal,
identify different types of bonds,
identify the various types of current and long-term liabilities,
determine the differences between the two main types of pension plans,
identify the different types of leases and the recording for both sides in a lease, and
recognize accounting requirements for the different types of stock, dividends, and equity reclassification.
Upon successful completion of this chapter, the user should be able to:
recognize the formats and elements of balance sheets and income statements, and
recognize the FASB Accounting Standards Codification ® (ASC).
Accounting is a service activity. Its function is to provide quantitative information, primarily financial in nature, about economic entities that is intended to be useful in making economic decisions—in making reasoned choices among alternative courses of action. These objectives are met primarily by the presentation of financial statements. Financial statements purport to present, in a condensed form, the economic events affecting an entity during a specific period of time and the cumulative effect of such events. The most important criterion to meet in a financial statement presentation is that the information provided be useful for decision making. Examples of useful information include information that helps a user of the financial statements predict cash flows and earning power, as well as information that increases management's ability to use resources efficiently and to understand contingencies that may have an effect on future operations.
Accounting operates in an environment almost as varied as the many types of entities that accounting serves. To provide a basis for comparison, it has been necessary to formulate certain underlying environmental assumptions on which financial accounting theory is based. The most important of these assumptions are as follows:
In order to properly report those economic events affecting an entity, the specific economic entity must be defined and separated from other entities. A distinction is also made between a business concern and its owners.
The business is not expected to liquidate in the near future. Where there is a reasonable expectation of an upcoming liquidation, the going concern assumption is abandoned. Liquidation accounting, characterized by the use of net realizable values rather than historical costs, is then employed.
In connection with preparing financial statements, management needs to evaluate whether there are conditions or events, considered in the aggregate, which raise substantial doubt about the organization's ability to continue as a going concern within one year after the date that the financial statements are issued.
That evaluation would be based on relevant information that is known and reasonably knowable at the date that the financial statements are issued and would include assessment of factors such as:
Current financial condition, including available liquid funds and available access to credit;
Obligations due or anticipated within one year;
The funds necessary to maintain operations considering its current financial condition, obligations, and other expected cash flows;
Other adverse conditions or events such as the following:
Recurring operating losses, working capital deficiencies, or negative cash flows.
Defaults on loans or similar agreements, denial of usual trade credit from suppliers, or a need to restructure debt to avoid default.
External matters, such as legal proceedings, legislation, or similar matters that might jeopardize the organization's ability to operate; loss of a key franchise, license, or patent; loss of a principal customer or supplier; or an uninsured or underinsured catastrophe such as a hurricane, tornado, earthquake, or flood.
Substantial doubt would exist when relevant conditions and events, considered in the aggregate, indicate that it's probable that the organization will be unable to meet its obligations as they become due within one year after the date that the financial statements are issued.
Based on the evaluation, if management identifies conditions or events that raise substantial doubt about the organization's ability to continue as a going concern, management will need to consider whether its plans will alleviate the substantial doubt. Management will need to consider whether: (1) it's probable that the plans will be effectively implemented and, if so, (2) it's probable that the plans will mitigate the conditions or events that raise substantial doubt.
Note
Generally, to be considered probable of being effectively implemented, management must have approved the plan before the date that the financial statements are issued.
If the substantial doubt is alleviated as a result of consideration of management's plans, the following would need to be disclosed in the notes to the financial statements:
Conditions or events that raised substantial doubt (before consideration of management's plans).
Management's evaluation of the significance of those conditions or events in relation to the organization's ability to meet its obligations.
Management's plans that alleviated the substantial doubt.
If substantial doubt is not alleviated after consideration of management's plans, the following would need to be disclosed in the notes to the financial statements:
A statement that there is substantial doubt about the organization's ability to continue as a going concern within one year after the date that the financial statements are issued.
Conditions or events that raise substantial doubt.
Management's evaluation of the significance of those conditions or events in relation to the organization's ability to meet its obligations.
Management's plans that are intended to mitigate the conditions or events that raise the substantial doubt.
Monetary units are used for the measurement and reporting of economic activity. Costs incurred at different points in time are intermingled in the accounts and, thus, it must be assumed that the purchasing power of the dollar remains constant over time. Inflation makes this assumption questionable. FASB ASC 255, Changing Prices, encourages enterprises to issue voluntary supplementary reports based on current costs and dollars of constant purchasing power. This information is furnished in addition to the usual historical cost financial statements.
This assumption recognizes the necessity of providing financial accounting information on a periodic and timely basis, so that it is useful in decision making.
Based upon these underlying environmental assumptions, a set of basic accounting principles has evolved. These assumptions and principles are implemented through the use of the basic accounting model, upon which the accounting for most profit-oriented entities is based. This model is composed of three main sub-models, each focusing on a different aspect of the economic activities of an enterprise.
Assets acquired, as well as liabilities incurred, by an enterprise are recorded at cost. Cost is generally defined as the cash equivalent amount that would be paid in an arm's-length transaction. When costs benefit more than one period, they are apportioned among the periods benefited through depreciation or amortization. Acquisition cost is considered a reliable basis upon which to account for assets and liabilities of a company. Historical cost has an advantage over other valuations—it is thought to be reliable. However, fair value information may be more useful than historical cost for certain types of assets and liabilities and in certain industries.
Revenue is recognized to reflect the transfer of goods and services to customers in an amount equal to the consideration that the entity receives or expects to receive. To apply that principle, an entity should:
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Identify the contract with a customer; |
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Identify the separate performance obligations in the contract; |
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Determine the transaction price; |
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Allocate the transaction price to the separate performance obligations; and |
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Recognize revenue when or as each performance obligation is satisfied. |
For income to be stated fairly, all expenses incurred in generating the revenues for a period must be recognized in that same period.
Accounting data should be both objectively determined and verifiable. While this does not preclude the use of estimates, they must be verifiable in the sense that an independent, knowledgeable person would find such estimates reasonable.
The relative importance of data, the cost-benefit relationship of additional accuracy, and the possible confusion resulting from the use of too much detail are considerations that must be weighed in determining the materiality of accounting information. When an item is immaterial, good accounting theory can be abandoned.
The usefulness of accounting information is enhanced when the information is presented in a manner consistent with that used in prior periods. This provides for interperiod comparability and the identification of trends. Consistency in the application of accounting principles also prevents income manipulation by management.
Financial statements should be presented in a manner that will reasonably assure complete and understandable communication of all relevant accounting information useful for decision making. When the nature of relevant information is such that it cannot appear in the accounts, this principle dictates that such relevant information be included in the accompanying notes to the financial statements.
Where use of the most appropriate accounting treatment is uncertain, when making estimates, or when data conflicts, the favored accounting treatment should be that which understates rather than overstates income or net assets. Conservatism should not be used in place of a more conceptually sound approach when the difference in results is of a material nature.
Assets = Liabilities + Owners' equity. The financial position sub-model purports to present the economic resources, the economic obligations, and the resulting residual interest in the assets of the entity to its owners. This information is reported by means of a balance sheet.
Revenues – Expenses = Net income. The purpose of the results of operations sub-model is to report on the relative success of the profit-directed activities of an entity. The revenues obtained through the sale of goods and services are compared to the expenses incurred in providing those goods and services. The resulting difference is the operating income or loss for the period. To arrive at net income, gains, losses, and the effect of accounting changes must be incorporated into the sub-model. The results of operations sub-model is formally represented by the income statement and the statement of changes in comprehensive income.
Cash flows from operating activities +(–) Cash flows from investing activities +(–) Cash flows from financing activities = Change in cash. The objective of this sub-model is to provide information about the cash receipts and cash payments of an entity during the period. The statement of cash flows reports the net cash provided or used by operating, investing, and financing activities, and the aggregate effect of those flows on cash during the period.
The balance sheet presents the assets, liabilities, and owners' equity of an entity at a specific point in time, measured in conformity with generally accepted accounting principles (GAAP).
SFAC No. 6 defines assets as probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events. Assets are classified in their order of liquidity and intended use.
Current Assets
Current assets are assets that are reasonably expected to be converted into cash or used during the normal operating cycle of the business or one year, whichever is longer.
Investments
Investments are assets that are held for control, appreciation, regular income, or a combination of the above. Examples include stocks, bonds, subsidiaries, land held as a future plant site, and the cash surrender value of life insurance. Also, in this category are special purpose funds, such as bond sinking funds and plant expansion funds.
Operational Assets
Operational assets are assets that are directly used by the enterprise in generating revenues.
Valuation Accounts
Valuation accounts are reductions or increases in an asset account to reflect adjustments beyond the historical cost or carrying amount of the asset. Valuation accounts are part of the related asset; they are neither assets nor liabilities in their own right.
To view this interactivity please view chapter 1, page 15
Interactivity information:
SFAC No. 6 defines liabilities as 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. Liabilities are classified according to their due date as either current or long-term.
Current Liabilities
Current liabilities are obligations whose liquidation is expected to require the use of existing current assets or the creation of other current liabilities.
Long-Term Liabilities
Long-term liabilities are obligations not requiring the use of existing current assets or the creation of current liabilities for their extinguishment.
Valuation Accounts
Valuation accounts may increase or decrease the carrying amount of a liability. Examples include the premium or discount on outstanding bonds payable. Valuation accounts are part of the related liability; they are neither assets nor liabilities in their own right.
SFAC No. 6 defines owners' equity as the residual interest in the assets of an entity that remains after deducting its liabilities.
Equity of Business Enterprises
An equity interest derives its value from being a potential source of distribution of cash or other assets to its owner. In case of liquidation, all liabilities must be satisfied first.
Equity is originally created by the initial investment of the enterprise owners. Subsequent investments by the owners, or the admission of new owners, increase equity, while distributions to owners decrease it.
Equity is also changed as a result of the operating activities of the enterprise and other events and circumstances affecting it. This combined effect constitutes comprehensive income.
Proprietorship
A proprietorship's equity consists of a single proprietor's equity account.
Partnership
A partnership's equity consists of one capital account for each partner. Each individual partner's capital account records her/his investment and subsequent allocations of income and withdrawals.
Corporation
A corporation's equity consists of several accounts that are segregated according to source.
Contributed Capital: Par or stated value represents minimum legal required capital as determined by articles of incorporation and state law. Additional paid-in capital reflects the amount received in excess of the par or stated value of the stock at the time of issuance.
Retained Earnings: Retained earnings are accumulated earnings less losses and dividends. They represent resources retained by the entity for use in expansion and growth.
Accumulated Other Comprehensive Income: Comprehensive income is defined as the change in equity (net assets) of a business entity during a period from transactions and other events and circumstances from non-owner sources. It includes all changes in equity during a period except those resulting from investments by owners and distributions to owners. Other comprehensive income includes revenues, expenses, gains, and losses that under GAAP are included in comprehensive income but excluded from net income.
Net Assets
The net assets of a nonprofit organization represent a residual, but are not an ownership interest.
Historical Cost: The acquisition cost less depreciation or amortization to date. While this method of valuation is both verifiable and systematic, it often fails to reflect either the current value of the asset or changes due to the purchasing power of the dollar.
Fair Value: FASB ASC 820, Fair Value Measurement, defines “fair value” as “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.”
Replacement Cost: Attempts to value assets on the basis of their current replacement cost. Current replacement cost is defined as the price of a new, similar item after allowance for use and depreciation. This method is used in the primary financial statements only in certain cases where the utility of inventory items has diminished.
Price-Level Adjusted: Historical cost adjusted to reflect changes in the general purchasing power of the dollar.
Discounted Cash Flows: Valuation of assets in terms of the present value of the future benefits associated with the ownership of the asset. Notes receivable and bond investments are valued at present value upon acquisition.
Liabilities are valued at their current debt equivalent. For long-term liabilities this implies discounting to their present value the future sums required to satisfy the liability. Due to materiality considerations, short-term liabilities are usually presented at their face amount.
The valuation of owners' equity depends on the amounts presented for assets and liabilities.
In January 2016, the FASB issued ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities, which, among other things, requires equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income. Entities no longer are able to classify equity investments as trading or available for sale (AFS), and they no longer recognize unrealized holding gains and losses on equity securities that were classified as AFS in OCI before they adopted the new guidance. Therefore, the AFS category will be eliminated for equity securities. The guidance is effective for calendar-year public business entities beginning in 2018. For all other calendar-year entities, it is effective for annual periods beginning in 2019 and interim periods beginning in 2020. ASU 2016-01 will be effective for public business entities, for fiscal years beginning after December 15, 2017. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2018.
This topic is beyond the scope of this course. For more information, read the actual guidance in ASU 2016-01.
The formats most commonly used are the account format and the report format.
Exhibit 1.1: Balance Sheet Formats (assumed amounts)
Account Format  |
Report Format |
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| Assets | Liabilities | Assets | $50,000 |
| $50,000 | $35,000 | ||
| Liabilities | $35,000 | ||
| Owners' equity | |||
| $15,000 | Owners' equity | $ 15,000 | |
Off-balance-sheet risk is the risk of accounting loss from a financial instrument that exceeds the amount recognized for the instrument in the balance sheet. Examples include standby loan commitments written, options, letters of credit, and noncancelable operating leases with future minimum lease commitments. Recent pronouncements attempt to eliminate off-balance-sheet risk by requiring that more risks be reflected within the balance sheet.
The income statement for a period presents the revenues, expenses, gains, losses, and net income (net loss) recognized during the period and thereby presents an indication, in conformity with GAAP, of the results of the enterprise's profit-directed activities during the period.
Revenues are inflows or other enhancements of assets of an entity or settlements of its liabilities (or a combination of both) during a period from delivering or producing goods, rendering services, or other activities that constitute the entity's ongoing major or central operations.
Inflows: Revenues represent actual or expected cash inflows (or equivalents) resulting from the entity's major or central operations.
Recognition: Revenues usually are recognized at the point of sale, in conformity with the basic accounting principle of revenue realization. Several exceptions to this principle are permitted under very specific circumstances.
Expenses are outflows or other use of assets or incurrence of liabilities (or a combination of both) from delivering or producing goods, rendering services, or carrying out other activities that constitute the entity's ongoing major or central operations during a period. Expenses represent actual or expected cash outflows (or equivalents) resulting from the entity's major or central operations. Expenses generally are recognized in accordance with one of three principles.
Associating Cause and Effect: Some costs are presumed to be directly related to specific revenues. Examples are cost of goods sold and sales commissions.
Systematic and Rational Allocation: If a direct association between costs and revenues is not apparent, costs must be allocated on a systematic and rational basis among the periods benefited. Depreciation of fixed assets, amortization of intangible assets, and allocation of prepaid rent and insurance are applications of this principle.
Immediate Recognition: Costs that are deemed to provide no discernible future benefits are expensed in the current period. Likewise, costs recorded as assets in prior periods that no longer have discernible benefits are expensed in the current period.
To view this interactivity please view chapter 1, page 24
Interactivity information:
Gains and losses are defined by SFAC No. 6 as increases (or decreases) in equity—i.e., net assets—from peripheral or incidental transactions of an entity and from all other transactions and other events and circumstances affecting the entity during a period, except those that result from revenues (expenses) or investments (withdrawals) by owners.
Operating: Gains and losses related to the business enterprise's central operations (e.g., write-down of inventory to lower of cost or market) are classified as operating.
Nonoperating: Gains and losses not attributable to operations are classified as nonoperating.
Two basic formats are used to present the income statement.
Focuses on two classifications of items: revenues and expenses. All revenues are added together to arrive at a total revenue figure. The sum of all expenses is subtracted from this figure. The resultant amount is “Income from Continuing Operations.”
Focuses on multiple classifications of revenue and expense items. This format is characterized by several intermediate subtotals, such as gross margin and operating income, which together produce “Income from Continuing Operations.”
Exhibit 1.2: Income Statement Formats (assumed amounts)
Please see Exhibit 1.2.
This statement is presented as a supplement to the income statement and serves as a link between beginning and ending retained earnings.
Exhibit 1.3: Statement of Retained Earnings
| Beginning balance, as reported | $ XXX |
| +/– Prior period adjustments, net of $______ tax | XXX |
| Beginning balance, as adjusted | XXX |
| + Net income (– Net loss) | XXX |
| – Dividends | (XXX) |
| Ending balance | $ XXX  |
SFAC No. 6 defines comprehensive income as “the change in equity of a business enterprise during a period from transactions and other events and circumstances from nonowner sources.” FASB ASC 220, Comprehensive Income, requires that comprehensive income be displayed prominently within a financial statement in a full set of general-purpose financial statements. Comprehensive income must be shown on the face of a statement, not just in the notes to the statements.
Comprehensive income includes all changes in equity during a period except those resulting from investments by owners and distributions to owners.
Over the life of the business, comprehensive income equals the net difference between cash receipts and outlays, excluding cash investments by owners and cash distributions to owners, regardless of whether cash or accrual accounting is used.
FASB ASC 220 divides comprehensive income into the components of net income and other comprehensive income.
Other comprehensive income (OCI) refers to revenues, expenses, gains, and losses that are included in comprehensive income, but excluded from net income.
There are two acceptable means of reporting comprehensive income: a single continuous statement of comprehensive income (one-statement approach) or a statement of net income and a separate statement of other comprehensive income (two-statement approach).
Comprehensive income is comprised of two components, net income and other comprehensive income. An entity must classify items of other comprehensive income by their nature: foreign currency items, minimum pension liability adjustments, unrealized gains and losses on certain investments in debt and equity securities, and certain gains and losses on hedging activities.
An entity must also display the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in capital in the equity section of a statement of financial position. An entity must disclose accumulated balances for each classification in that separate component of equity on the face of the statement of financial position, in the statement of changes in equity, or in the notes to the financial statements.
Exhibit 1.4: Comprehensive Income Reporting (Separate Statement)
| Net Income | $XXX | ||
| Foreign currency adjustments, net of tax of $XXX | $XXX | ||
| Unrealized holding gain/loss arising during period, net of tax of $XX |
$XXX |
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| Reclassification adjustment, net of tax of $XX, for gain/loss included in net income |
XXX |
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| Unrealized Gain/Loss on Marketable Securities | XXX | ||
| Minimum pension liability adjustment, net of tax of $XX | XXX |
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| Other Comprehensive Income | XXX |
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| Comprehensive Income | $XXX |
FASB ASC 230, Statement of Cash Flows, requires that a statement of cash flows be issued whenever a balance sheet and an income statement are issued. This financial statement provides relevant information about the cash receipts and cash payments of an enterprise during a period.
The statement of cash flows classifies cash receipts and cash payments resulting from operating, investing, and financing activities.
Noncash investing and financing transactions are not reported in the statement of cash flows because the statement reports only the effects of operating, investing, and financing activities that directly affect cash flows. If significant, noncash investing and financing transactions are reported in related disclosures.
Net cash from operating activities can be determined under either the direct or indirect method. Under the direct approach, operating cash payments are deducted from operating cash receipts, effectively resulting in a cash basis income statement. The indirect approach converts net income to net cash flow from operating activities by adding back noncash charges in the income statement to net income and subtracting noncash credits from net income.
The FASB intends Statements of Financial Accounting Concepts (SFACs) to set forth objectives and fundamentals that will be the basis for future development of financial accounting and reporting standards. The idea is to create a conceptual framework consisting of coherent interrelated objectives and principles that will lead to consistent standards of accounting and reporting. SFACs do not establish standards prescribing accounting procedures or disclosures, nor supersede, amend, or otherwise modify present GAAP; therefore, SFACs are not considered authoritative pronouncements.
SFAC Nos. 1, 2, and 3 have been replaced or superseded. SFAC No. 4 sets objectives of financial reporting for nonbusiness enterprises and as such is not included in this discussion material.
Some information is provided well by financial statements, and some is provided well or can only be disclosed in notes to financial statements, parenthetically, or by supplementary information or other means of financial reporting. The scope of SFAC No. 5 is limited to recognition and measurement in financial statements of business enterprises.
A full set of financial statements provides information that is necessary to satisfy the broad purposes of financial reporting. A full set of financial statements includes information (some of which may be combined in a single statement) showing the financial position at the end of the period, earnings (net income) for the period, comprehensive income (total nonowner changes in equity) for the period, cash flows during the period, and investments by and distributions to owners during the period.
To view this interactivity please view chapter 1, page 35
Interactivity information:
The full set of articulated financial statements discussed in SFAC No. 5 is based on the concept of financial capital maintenance. The main difference between the two concepts involves the effect of price changes during the period. Under the financial capital concept, if the effects of price changes are recognized, they are reported as holding gains or losses, (i.e., included in income). Under the physical capital concept, such changes are considered adjustments to equity.
Financial Capital
Under this concept, a return on financial capital results only if the financial (money) amount of an enterprise's net assets at the end of a period exceeds the corresponding amount at the beginning of the period, after excluding the effects of transactions with owners. The financial capital concept is the traditional view and is the capital maintenance concept in present financial statements and comprehensive income.
Physical Capital
Under this concept, a return on physical capital results only if the physical productive capacity of the enterprise at the end of the period exceeds its capacity at the beginning. Thus, the physical capital concept can be implemented only if the enterprise's productive assets, inventory, etc., are measured by their current cost.
The process of formally recording or incorporating an item into the financial statements of an entity as an asset, liability, revenue, expense, or the like. An item and information about it must meet four fundamental recognition criteria to be recognized, subject to cost-benefit and materiality considerations.
Definition: The item meets the definition of an element of financial statements.
Measurability: The item has a relevant attribute measurable with sufficient reliability.
Relevance: The information may make a difference in user decisions.
Reliability: The information is representationally faithful, verifiable, and neutral.
Revenues and gains are recognized when both realized, or realizable, and earned.
Realized or Realizable
Revenues and gains are realized when products (goods or services), merchandise, or other assets are exchanged for cash or claims to cash. Revenues and gains are realizable when related assets received or held are readily convertible to known amounts of cash or claims to cash.
Earned
Revenues are not recognized until earned. For gains, being earned is generally less significant than being realized or realizable, since gains commonly involve no “earning process.”
Expenses and losses are generally recognized when an entity's economic benefits are used up or when previously recognized assets are expected to provide reduced or no further benefits.
Consumption of Economic Benefits
May be recognized either directly or by relating them to revenues recognized during the period.
Loss or Lack of Benefit
Expenses or losses are recognized if it becomes evident that previously recognized future economic benefits of assets have been reduced or eliminated, or that liabilities have been incurred or increased, without associated economic benefits.
SFAC No. 6 replaced SFAC No. 3. It identifies ten elements of financial statements: seven elements of financial statements of both business enterprises and not-for-profit organizations—assets, liabilities, equity (business enterprises) or net assets (not-for-profit organizations), revenues, expenses, gains, and losses; and three elements of business enterprises only—investment by owners, distributions to owners, and comprehensive income.
Accrual accounting attempts to record the financial effects on an entity of transactions and other events and circumstances that have cash consequences for the entity in the periods in which those transactions, events, and circumstances occur, rather than only in the periods in which cash is received or paid by the entity. Accrual accounting is characterized by the use of accruals, deferrals, allocations, and amortizations.
Accrual
Accrual is the accounting process of recognizing assets or liabilities and the related liabilities, assets, revenues, expenses, gains, or losses for amounts expected to be received or paid, usually in cash, in the future.
Deferral
Deferral is the accounting process of recognizing a liability resulting from a current cash receipt or an asset resulting from a current cash payment with deferred recognition of revenues, expenses, gains, or losses.
Allocation
Allocation is the accounting process of assigning or distributing an amount according to a plan or a formula.
Amortization
Amortization is the accounting process of reducing an amount by periodic payments or write-downs. It is an allocation process for accounting for prepayments and deferrals by reducing a liability or an asset and recognizing a revenue or an expense.
Realization
Realization is the process of converting noncash resources and rights into money. This term is most precisely used in accounting and financial reporting to refer to sales of assets for cash or claims to cash. The related terms realized and unrealized, therefore, identify revenues or gains or losses on assets sold and unsold, respectively.
Recognition
Recognition is the process of formally recording or incorporating an item in the financial statements of an entity. Thus, an asset, liability, revenue, expense, gain, or loss may be recognized (recorded) or unrecognized (unrecorded).
Combined or simultaneous recognition of the revenues and expenses that result directly and jointly from the same transactions and other events.
Period Costs
Some costs cannot be directly related to particular revenues, yet result in benefits that are exhausted in the same period in which the cost was incurred. These costs are usually recognized as expenses in the period in which incurred. Examples: administrative salaries, store utilities, etc.
Cost Allocation
Other costs yield their benefits over two or more periods of time. These costs are usually allocated to the periods benefited through a systematic and rational cost allocation method (e.g., depreciation and amortization).
SFAC No. 7 presents the FASB's conclusions about the use and approach to making interest computations in financial reporting. It is limited to measurement issues and does not address recognition.
Most accounting measurements use an observable marketplace-determined amount, such as cash exchanged, current cost, or current market value. In other instances, estimates of future cash flows must be used as the basis for measuring an asset or a liability. SFAC No. 7 provides a framework for using future cash flows as the basis for accounting measurements at initial recognition or fresh-start measurements as well as for the interest method of amortization. Additionally, it provides general principles that govern the use of present value computations, particularly when the amount and/or timing of future cash flows are uncertain.
In order to provide more relevant information (a primary qualitative characteristic of financial reporting), present value must represent some observable measurement attribute of assets or liabilities. In the absence of observed transaction prices, accounting measurements at initial recognition and fresh-start measurements should attempt to capture the elements that taken together would comprise a market price if one existed (fair value). While the expectations of management are often useful and informative, ultimately, it is the market that dictates market price when exchanges occur. For certain assets or liabilities, management's estimates may be the only information available on which to value the asset or liability. In that case, the use of present value can be seen as a surrogate for market value.
An accounting measurement that uses present value should reflect the uncertainties inherent in the estimated cash flows. This means risk should be incorporated into the computation. SFAC No. 7 provides guidance on how to incorporate risk into the analysis, including its effect on both the timing and amount of future cash flows.
In the past, present value computations have relied on a single estimate of cash flows and a single interest rate. SFAC No. 7 calls for the use of expected cash flows, which incorporates uncertainty, use of ranges, and probabilistic computations in the projection of future cash flows.
In measuring liabilities, the SFAC No. 7 indicates that there are different issues at hand. Nonetheless, the ultimate objective remains the same—to reflect fair value. SFAC No. 7 provides additional guidance for measuring liabilities.
Credit risk can affect a variety of components in the present value computation and should be incorporated in the present value computation. Additionally, in measuring liabilities, the entity's credit standing should always be incorporated into that measurement.
SFAC No. 8 includes two chapters of the new Conceptual Framework resulting from a joint project between the FASB and the IASB designed to improve and converge each organization's Conceptual Framework. SFAC Nos. 1 and 2 have been superseded by SFAC No. 8. As the FASB and IASB complete additional phases of their joint project, new chapters will be added to SFAC No. 8, and other Concepts Statements will be superseded.
The objective of general purpose financial reporting forms the foundation of the Conceptual Framework. That objective is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders, and other creditors to make decisions about providing resources to the entity. The decisions include buying, selling, or holding equity and debt instruments and providing or settling loans and other forms of credit.
Usefulness
Users need to assess the amount, timing, and uncertainty of future net cash inflows to the entity in order to form opinions about the returns that they expect from an investment. Specifically, users need information about the resources of an entity, claims against the entity, and how efficiently and effectively the entity's management and governing board have discharged their responsibilities to use the entity's resources. Since most external users cannot require entities to provide information directly to them, they must rely upon general purpose financial statements. As such, these external users are the primary users to whom general purpose financial reports are directed.
Limitations
General purpose financial statements are not intended to show the value of a reporting entity; but they provide information to help users to estimate the value of the reporting entity. They do not and cannot provide all the information that existing and potential users need. Users should also consider relevant and useful information from other sources, such as general economic conditions and expectations, political events and political climate, and industry and company outlooks. To a large extent, financial reports are based on estimates, judgments, and models rather than exact depictions.
Information about the financial position of a reporting entity is information about the entity's economic resources and claims against the entity. This information, along with changes in economic resources and claims, are provided in the general purpose financial reports.
Economic Resources and Claims
A reporting entity's financial strengths and weaknesses can be identified through information about the nature and amount of the reporting entity's economic resources available for use in operations. Users need to know not only the nature and amount of resources available for use in an entity's operations, but they also need to know the different types of resources. Different types of economic resources affect a user's assessment of the reporting entity's prospects for future cash flows differently.
Changes in Economic Resources and Claims
Changes in resources and claims result from the entity's financial performance and other transactions, such as issuing debt or equity instruments. Users need to be able to distinguish between both of these changes in order to properly assess the prospects of future cash flows from the entity.
Financial performance information helps users to evaluate the return that the entity has produced. This information also helps users assess how well management has discharged its responsibilities to make efficient and effective use of the entity's resources; in assessing the uncertainty of future cash flows; and in predicting the entity's future returns on its economic resources.
Financial Performance Reflected by Accrual Accounting
Accrual accounting shows the effects of transactions on an entity's economic resources and claims in the periods in which those effects occur; not based on the cash receipts and payments that occurred during that period. Accrual accounting results in information that provides a better basis for assessing the entity's past and future performance than cash-based accounting. Information about changes in an entity's economic resources and claims other than by obtaining additional resources directly from investors and creditors is useful in assessing the entity's past and future ability to generate net cash flows.
Financial Performance Reflected by Past Cash Flows
Information about an entity's cash flows during a period helps users to assess the entity's ability to generate future net cash flows. Cash flow information helps users understand an entity's operations, evaluate its financing and investing activities, assess its liquidity or solvency, and interpret other information about financial performance.
Changes Not Resulting from Financial Performance
Nonfinancial reasons, such as issuing additional ownership shares, may result in changes to an entity's economic resources and claims. Users need a complete understanding of why the reporting entity's economic resources and claims have changed and the implications of those changes for its future financial performance.
The qualitative characteristics of useful financial information identify the types of information that are likely to be useful to users for making decisions about the reporting entity on the basis of financial information in its financial statements, as well as financial information provided in other ways. For financial information to be useful, it must be relevant and faithfully represent what it purports to represent. The usefulness is enhanced if it is comparable, verifiable, timely, and understandable.
Fundamental Qualitative Characteristics
Relevance and faithful representation are fundamental qualitative characteristics.
Relevance: Information is relevant if it is capable of making a difference in a decision by helping users to form predictions about the outcomes of past, present, and future events or to confirm or correct prior expectations. Predictive, or confirmatory, value is the trait that allows financial information to make a difference.
Information has predictive value if it can be useful in predicting future outcomes by users. Confirmatory value provides feedback (confirms or changes) about previous assessments. Predictive value and confirmatory value are interrelated.
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. Materiality is an entity-specific aspect of relevance that is dependent upon the relation to the context of an individual entity's financial report.
Faithful Representation: A perfectly faithful representation would have three characteristics. It would be complete, neutral, and free from error.
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Complete information includes all the information necessary for a user to understand the economic phenomena being reported, including all necessary descriptions and explanations. This may include data about the quality and nature of the item, factors and circumstances that might affect the quality and nature of the item, and the process used to determine the numerical quantity. |
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Neutral information is without bias in the selection or presentation of financial information. |
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Free of error means there are no errors or omissions in the description or preparation of the information reporting on the phenomenon. |
Applying the Fundamental Qualitative Characteristics
First, identify an economic phenomenon that can be useful to users. Second, identify the type of information about the phenomenon that would be most relevant if it is available and can be faithfully represented. Third, if the information is available and faithfully representational, the process of satisfying the fundamental qualitative characteristics ends at this point. If not, repeat the process with the next most relevant information.
Enhancing Qualitative Characteristics
These characteristics enhance the usefulness of information that is relevant and faithfully represented. They can also help in determining which of two ways should be used to depict a phenomenon if both ways are considered equally relevant and faithfully represented.
Comparability: Information is more useful if it helps users to choose between alternative decisions (i.e., buy or sell an investment) by comparing similar information about other entities. It aids users in identifying and understanding similarities and differences among items. Consistency is related to comparability, and refers to the use of the same method for making comparisons across entities or periods of time. Consistency helps to achieve comparability.
Verifiability: When a large number of independent observers derive similar results using the same measurement methods, information is verifiable. It can be direct or indirect. If information cannot be verified (i.e., projections), it would be helpful to disclose the underlying assumptions, methods of compiling the information, and other factors and circumstances that support the information.
Timeliness: Information is timely if it is available to a decision maker before it loses its capacity to influence decisions. Older information is generally less useful than newer information, but older information can assist in identifying and assessing trends.
Understandability: Classifying, characterizing, and presenting information clearly and concisely makes it understandable. Complex information should not be omitted in an attempt to make financial statements easy to understand. Users of financial statements are assumed to possess a reasonable knowledge of business and economic activities.
Applying the Enhancing Qualitative Characteristics
These characteristics should be maximized to the extent possible, but the underlying information must first be relevant and faithfully represented in order to be useful.
Cost Constraint on Useful Financial Reporting
Cost is a pervasive constraint, and must be balanced with the benefits of providing that information. Different assessments of costs and benefits may be reasonable given the different sizes of entities, ways of raising capital (publicly or privately), different users' needs, or other factors.
FASB ASC 820, Fair Value Measurement, defines “fair value” as “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.”
The definition of fair value is based on an exit price (for an asset, the price at which it would be sold) rather than an entry price (for an asset, the price at which it would be bought), regardless of whether the entity plans to hold or sell the asset.
FASB ASC 820 emphasizes that fair value is market based rather than entity specific; fair values must rest on assumptions that market participants would use in pricing the asset or liability. Thus, the optimism that often characterizes an asset owner must be replaced with the skepticism that typically characterizes a risk averse buyer.
The term “fair value hierarchy,” as used in FASB ASC 820, refers to the relative reliability of inputs to a valuation technique used in arriving at a fair value estimate. The three-level hierarchy is essential to the fair value disclosure requirements. The lower the level of the input for a fair value measurement, the more extensive the disclosure requirement. Exhibit 1.5 summarizes the hierarchy, with Level 1 representing the most reliable inputs, and Level 3 the least.
Exhibit 1.5: Hierarchy of Inputs to Valuation Techniques
Please see Exhibit 1.5.
A fair value measurement may be based on inputs from more than one level in the hierarchy. For example, the inputs for an income valuation technique may be risk-free interest rates and credit spreads that are observable (Level 1 or 2 inputs) and entity-specific projections of future cash flows to be derived from the use of the asset or asset group (Level 3). In determining the level of the fair value measurement itself, the lowest-level input that is significant to the fair value measurement determines the hierarchy level of the measurement.
The lowest-level-significant-input assumption means that many fair value measurements of nonfinancial assets and asset groups or reporting units will be Level 3 measurements because of their reliance on Level 3 inputs, such as forecasts of the reporting unit's or asset group's future cash flows. Fair value measurements of financial instruments, however, may be based entirely on higher level inputs in some situations (e.g., measures of instruments that are traded in active markets or of instruments with contractual cash flows and interest rates that are observable as Level 2 inputs). In all cases, the inputs should be consistent with the valuation premise and be based on the assumptions that the entity reasonably believes that market participants would use. Thus, if market participants would be expected to use an asset, the inputs would be based on an in-use valuation premise even if the reporting entity would not plan to use the asset on that basis.
The disclosures about fair value shed light on the relative reliability of fair value measurements. FASB ASC 820 requires separate disclosures of items that are measured at fair value on a recurring basis (e.g., an investment portfolio) versus items that are measured at fair value on a nonrecurring basis (e.g., an impaired asset).
Nonrecurring Basis
For items that are measured on a nonrecurring basis at fair value:
A separate table for assets and for liabilities that displays the balance sheet fair value carrying amount of major classes of assets and of liabilities is required.
Within each table, the assets and liabilities measured at fair value in each major class are separated into the level of the hierarchy on which fair value is based. The table also includes total gains and losses recognized for each major class.
Recurring Basis
For items that are measured on a recurring basis at fair value:
Tables similar to those required for non-recurring items are required.
Additional information regarding fair values based on Level 3 (unobservable) inputs, including a roll forward analysis of fair value balance sheet amounts and disclosure of the unrealized gains and losses for Level 3 items held at the reporting date is required.
Entities are permitted to measure many financial instruments and certain other assets and liabilities at fair value on an instrument-by-instrument basis under a fair value option (FVO) available under FASB ASC 825, Financial Instruments.
The FVO applies primarily to financial assets and financial liabilities. In addition to certain commonly recognized financial assets and financial liabilities, such as loans receivable and payable, the following items qualify for the FVO under FASB ASC 825:
Equity-method investments that are subject to FASB ASC 323, Investments—Equity Method and Joint Ventures
Investments in equity securities that do not have readily determinable fair values, as described in FASB ASC 320, Investments—Debt and Equity Securities
Rights and obligations under insurance contracts that are financial instruments, as well as under insurance contracts that are not financial instruments, because they require or permit the insurer to provide goods or services rather than a cash settlement and the insurer can settle by paying a third party to provide goods and services
Rights and obligations under a warranty that is not a financial instrument because it requires or permits the warrantor to provide goods or services rather than a cash settlement, and the warrantor can settle by paying a third party to provide goods and services
Host financial instruments that are the result of separating an embedded nonfinancial derivative instrument from a nonfinancial hybrid instrument, as required by FASB ASC 815, Derivative and Hedging (for example, a nonfinancial hybrid instrument in which the value of the bifurcated embedded derivative is payable in cash, services, or merchandise but the debt host is payable only in cash)
Firm commitments that would otherwise not be recognized at their inception and that involve only financial instruments (for example, a forward purchase contract for a loan that is not readily convertible to cash and that consequently does not qualify as a derivative instrument under FASB ASC 815)
Written loan commitments
The following items are explicitly excluded from the scope of the FVO:
An interest in an entity that the investor is required to consolidate (e.g., a subsidiary or a primary beneficiary's interest in a variable interest entity)
Employers' and plans' financial obligations with respect to pension benefits, other postretirement benefits, post-employment benefits, employee stock options, employee stock purchase plans, and other forms of deferred compensation arrangements
Financial assets and liabilities recognized under lease contracts, as defined in FASB ASC 840, Leases, (except for a guarantee of a third-party lease obligation or a contingent obligation arising from a cancelled lease)
Financial instruments, in whole or in part, classified as equity (including “temporary” or “mezzanine” equity)
Note
Convertible debt that has a non-contingent beneficial conversion feature would be precluded from the FVO due to its equity classification.
Deposit liabilities (deposits that can be withdrawn on demand) of banks, credit unions, savings and loan associations, and other similarly regulated financial institutions
FASB ASC 825 permits entities to choose the FVO on an instrument-by-instrument basis; therefore, an entity can elect the FVO for certain loans, individual shares, or participations, but not for others. If the FVO is not elected for all eligible instruments within a group of similar instruments, the entity is required to disclose the reasons for its partial election, and disclose the amounts to which it applied the FVO and the amounts to which it did not apply the FVO within that group. Exceptions to the instrument-by-instrument election exist for the following:
If multiple advances are made to one borrower under a single instrument (such as a line of credit or construction loan) and the individual advances lose their identity and become part of the larger loan balance, the FVO may only be applied to the larger loan balance and not the individual advances.
If an investment would otherwise be accounted for under the equity method of accounting pursuant to FASB ASC 323, the election of the fair value option must be applied to all of the investor's financial interests (equity and debt, including guarantees) in that investee that would qualify for the FVO, rather than on an instrument-by-instrument basis.
The FVO must be applied to all claims and obligations under the eligible insurance or reinsurance contract.
If the FVO is elected for insurance contracts containing integrated or non-integrated contract features or coverages, the FVO cannot be elected for only the non-integrated contract features or coverages even though those features and coverages are accounted for separately under FASB ASC 944, Financial Services—Insurance.
Note
The FVO does not need to be elected for all instruments issued or acquired in a single transaction. For example, an investor in a bond offering may apply the FVO to a portion of the bonds acquired in a single transaction; however, entities are required to disclose the reasons for partial election and disclose the amounts to which it applied the FVO and the amounts to which it did not apply the FVO within that group. A financial instrument that represents a single contract may not be further separated into parts for purposes of electing the FVO.
An entity can choose to apply the FVO on the date when any one of the following occurs:
The entity first recognizes the eligible item.
The entity enters into an eligible firm commitment.
Financial assets that, because of specialized accounting principles, have been reported at fair value with unrealized gains and losses included in earnings cease to qualify for fair value measurement (e.g., an investment ceases to be subject to FASB ASC 946, Financial Services—Investment Companies).
An investment in an entity becomes subject to the equity method of accounting (e.g., the investor acquires additional shares of the investee's common stock).
An investor ceases to consolidate a subsidiary or variable interest entity but retains an interest (e.g., because the investor no longer holds a majority voting interest but continues to hold a smaller amount of common stock).
As a result of a particular event, an eligible item must be measured at fair value at the time of the event (“remeasurement event”) but is not remeasured at fair value each reporting date after that, excluding recognition of impairment under lower-of-cost-or-market (LCM) accounting or other-than-temporary impairment (OTTI). Remeasurement events include business combinations as defined in FASB ASC 805, Business Combinations; the initial consolidation or deconsolidation of a subsidiary or a variable interest entity, or the reconsolidation of a deconsolidated variable interest entity; and significant modifications of debt, as defined by FASB ASC 470, Debt.
The American Institute of Accountants (known today as the American Institute of Certified Public Accountants, or AICPA) created in 1932 a Committee on Cooperation with Stock Exchanges. The Committee made a series of recommendations, which later were adopted by the AICPA.
In 1939, the Institute formed a second committee, the Committee on Accounting Procedures (CAP), with the objective of narrowing the areas of differences and inconsistencies in the practice of accounting. During its existence, CAP issued 51 pronouncements, known as Accounting Research Bulletins (ARBs). ARB No. 43 consisted of a rewrite of the prior 42 pronouncements.
CAP was replaced in 1959 by the Accounting Principles Board (APB). From 1959 through 1973, the APB promulgated 31 pronouncements known as Opinions. In addition, the Board issued four Statements. Unlike Opinions, APB Statements were simply recommendations, not requirements.
The APB was substituted in 1973 by the Financial Accounting Standards Board (FASB), an independent private-sector body composed of seven full-time members and a 35-member Advisory Council.
On June 3, 2009, the FASB voted to approve the FASB Accounting Standards Codification ® as the single source of authoritative nongovernmental U.S. Generally Accepted Accounting Principles (GAAP) to be launched on July 1, 2009. The Codification was effective for interim and annual periods ending after September 15, 2009. All existing accounting standard documents were superseded. All other accounting literature not included in the Codification is considered nonauthoritative.
The Codification reorganizes the thousands of U.S. GAAP pronouncements into roughly 90 accounting topics, and displays all topics using a consistent structure. Also included is relevant Securities and Exchange Commission (SEC) guidance that will follow the same topical structure in separate sections in the Codification.
The Accounting Standards Codification includes all standards issued by a standard-setter within levels A through D of the previous GAAP hierarchy. It does not include standards for state and local governments. Literature issued by various standard setters for all nongovernmental entities included in the Codification is as follows:
Financial Accounting Standards Board (FASB)
Statements (FAS)
Interpretations (FIN)
Technical Bulletins (FTB)
Staff Positions (FSP)
Staff Implementation Guides (Q&A)
Emerging Issues Task Force (EITF)
Abstracts
Topic D
Derivative Implementation Group (DIG) Issues
Accounting Principles Board (APB) Opinions
Accounting Research Bulletins (ARB)
Accounting Interpretations (AIN)
American Institute of Certified Public Accountants (AICPA)
Statements of Position (SOP)
Audit and Accounting Guides (AAG)—only incremental accounting guidance
Practice Bulletins (PB)
Technical Inquiry Service (TIS)—only for Software Revenue Recognition
The FASB concluded that the Codification represents authoritative GAAP. Therefore, the Codification does not include the FASB Statements of Financial Concepts nor does it include guidance for non-GAAP matters such as the following:
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Other Comprehensive Basis of Accounting (OCBOA) |
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Cash Basis |
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Income Tax Basis |
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Regulatory Accounting Principles (RAP) |
Topics represent a collection of related guidance. For example, “Leases” is a Topic. The Topics correlate very closely to standards issued by the International Accounting Standards Board. The Topics reside in four main areas as follows:
Presentation
These Topics relate only to presentation matters and do not address recognition, measurement, and derecognition matters. Topics include Income Statement, Balance Sheet, Earnings per Share, and so forth.
Financial Statement Accounts
The Codification organizes Topics in a financial statement order including Assets, Liabilities, Equity, Revenue, and Expenses. Topics include Receivables, Revenue Recognition, Inventory, and so forth.
Broad Transactions
These Topics relate to multiple financial statement accounts and are generally transaction-oriented. Topics include Business Combinations, Derivatives, Nonmonetary Transactions, and so forth.
Industries
These Topics relate to accounting that is unique to an industry or type of activity. Topics include Airlines, Software, Real Estate, and so forth.
Subtopics represent subsets of a Topic and are generally distinguished by type or by scope. For example, Lessee and Lessor are two Subtopics of the Leases Topic. Each Topic contains an Overall Subtopic representing pervasive guidance for the Topic. Each additional Subtopic represents incremental or unique guidance not contained in the Overall Subtopic. In some cases, the Overall Subtopic represents overall guidance. In other cases, Topics may not contain overall guidance, but instead may represent miscellaneous content that does not fit into another Subtopic.
Subtopics unique to a Topic use classification numbers between 00 and 99. In addition, Topics—primarily Industry Topics—may contain Subtopics that mirror the general Topics. For example, the general Receivables Topic is 310, the general Inventory Topic is 330, and the Agriculture Topic is 905. The Agriculture Topic may include Subtopics for Receivables, Inventory, and so forth. The Subtopic classification number is the classification number of the related Topic. In this case:
Agriculture—Receivables is 905-310
Agriculture—Inventory is 905-330
Sections represent the nature of the content in a Subtopic such as Recognition, Measurement, Disclosure, and so forth. Every Subtopic uses the same Sections unless there is no content for a particular Section. Similar to Topics, Sections correlate very closely with Sections of individual International Accounting Standards. The Sections of each Subtopic are listed in Exhibit 1.6.
Exhibit 1.6: FASB Codification Sections
Please see Exhibit 1.6.
The FASB does not consider new standards as authoritative in their own right. Instead, the new standards serve only to update the Codification and provide the basis for conclusions for the standard.
New standards are composed of two items: the standard (including the Basis for Conclusions) and an appendix containing Codification Update instructions. The title of the combined set of standard and instructions is “Accounting Standards Update YYYY-XX,” where YYYY is the year and XX is the sequential number for each Update. For example, the combined numbers would be 2021-01, 2021-02, etc. All authoritative GAAP issued by the FASB is issued in this format, regardless of the form in which such guidance may have been issued previously (for example, EITF Abstracts, FASB Staff Positions, FASB Statements, and FASB Interpretations).
In 2012, after seeking and considering extensive public comment, the Financial Accounting Foundation (FAF) Board of Trustees established a new body to improve the process of setting accounting standards for private companies.
The Private Company Council (PCC) has two principal responsibilities. Based on criteria mutually developed and agreed to with the FASB, the PCC will determine whether exceptions or modifications to existing nongovernmental U.S. GAAP are necessary to address the needs of users of private company financial statements. The PCC will identify, deliberate, and vote on any proposed changes, which will be subject to endorsement by the FASB and submitted for public comment before being incorporated into GAAP. The PCC also serves as the primary advisory body to the FASB on the appropriate treatment for private companies for items under active consideration on the FASB's technical agenda.
In 2013, the FASB and the PCC issued Private Company Decision-Making Framework: A Guide for Evaluating Financial Accounting and Reporting for Private Companies. The primary purpose of this Guide is to assist the FASB and the PCC in determining whether and in what circumstances to provide alternative recognition, measurement, disclosure, display, effective date, and transition guidance for private companies reporting under U.S. GAAP. This Guide provides considerations for the PCC and the FASB in making user-relevance and cost-benefit evaluations for private companies under the existing conceptual framework. The Guide is intended to be a tool to help the FASB and the PCC identify differential information needs of users of public company financial statements and users of private company financial statements and to identify opportunities to reduce the complexity and costs of preparing financial statements in accordance with U.S. GAAP.
One of the critical components to developing the Guide was determining what organizations would be within its scope. The FASB project on defining a public business entity distinguished a public company from a private company and addressed some of the organizations that would not be within the scope of the Guide; other organizations not in the scope of the Guide are not-for-profits and employee benefit plans. As a result of this project, a business entity (which excludes a not-for-profit organization or an employee benefit plan) meeting any one of the following criteria would be considered public:
It is required by the U.S. Securities and Exchange Commission (SEC) to file or furnish financial statements, or does file or furnish financial statements (including voluntary filers) with the SEC (including other entities whose financial statements or financial information are required to be or are included in a filing).
It is required by the Securities Exchange Act of 1934, as amended, or rules or regulations promulgated under the Act, to file or furnish financial statements with a regulatory agency, other than the SEC.
It is required to file or furnish financial statements with a regulatory agency (foreign or domestic) in preparation for the sale of or for purposes of issuing securities that are not subject to contractual restrictions on transfer.
It has (or is a conduit bond obligor for) securities that are traded, listed, or quoted on an exchange or an over-the-counter market.
Its securities are not subject to contractual restrictions on transfer, and it is required to prepare U.S. GAAP financial statements (including footnotes) and make them publicly available on a periodic basis (for example, interim or annual periods), pursuant to a legal, contractual, or regulatory requirement. An entity must meet all those conditions to meet criterion (E).
Note
An entity may meet the definition of public business entity solely because its financial statements or financial information is included in another entity's filing with the SEC. In that case, the entity is only a public business entity for purposes of financial statements filed or furnished with the SEC.
Inflation makes which of the following assumptions questionable?
| A | Going concern |
| B | Economic entity |
| C | Unit-of-measure |
| D | Periodicity |
Which of the following are assets that are held for control, appreciation, regular income, or a combination of the above?
| A | Current assets |
| B | Investments |
| C | Operational assets |
| D | Valuation accounts |
A business entity would not be in compliance with FASB ASC 220, Reporting Comprehensive Income, if the entity does which of the following?
| A | Reports comprehensive income by preparing a statement of net income and a separate statement of other comprehensive income |
| B | Classifies items of other comprehensive income by their nature, such as foreign currency items or minimum pension liability adjustments |
| C | Reports comprehensive income in a statement of equity |
Financial information is which of the following, when it is relevant and faithfully represents what it purports to represent?
| A | Comparable |
| B | Verifiable |
| C | Useful |
| D | Timely |
Which of the following is not included in the FASB Accounting Standards Codification ®?
| A | FASB Statements and Interpretations |
| B | FASB Technical Bulletins |
| C | AICPA Accounting Interpretations |
| D | FASB Statements of Financial Accounting Concepts |