Wall Street Prep-Accounting Crash Course with Intro
Questions and Answers.
What is accounting? - ANS Accounting is the language of business; it is a standard set
of rules for measuring a company's financial performance.
Assessing a company's financial performance is important for:
The firm's officers (managers and employees)
Investors
Lenders
General public
Standard financial statements serve as a "yardstick" of communicating financial
performance to the general public.
Why is Accounting Important? - ANS Enables managers to make corporate decisions
Enables the general public to make investment decisions
Who Uses Accounting? - ANS Used by a variety of organizations - from the federal
government to non-profit organizations to small businesses to corporations
We will discuss accounting rules as they pertain to publicly-traded companies
Accounting Regulations - ANS Accounting attempts to standardize financial information
and follows rules and regulations
These rules are called Generally Accepted Accounting Principles (GAAP)
In the US, the Securities and Exchange Commission (SEC) authorizes the Financial
Accounting Standards Board (FASB) to determine accounting rules
GAAP comes from the Statements of Financial Accounting Standards (SFAS) issued by
the FASB
An Overview of the SEC - ANS A US federal agency established by the US Congress in
1934
Primary mission is "to protect investors and maintain the integrity of the securities
markets"
Division of Corporate Finance oversees FASB
An Overview of FASB - ANS Established in 1973 as an independent body to carry out
the function of codifying accounting standards on the behalf of the SEC
Composed of seven full-time members appointed for five years by the Financial Account
Foundation (FAF)
Decisions are influenced by:
International Financial Reporting Standards (IFRS) - ANS over 100 countries, including
the EU, UK, Canada, Australia, and Russia, have adopted a unified set of international
accounting standards (IFRS)
Although we have seen unprecedented convergence over the last few years between
US GAAP and IFRS, some differences remain
,Assumption 1: Accounting Entity - ANS a Company is considered a separate "living"
enterprise, apart from its owners
In other words, a corporation is a "fictional" being
Assumption 2: Going Concern - ANS a Company is considered a "going concern" for
the foreseeable future; it is assumed to remain in existence indefinitely
Assumption 3: Measurement - ANS Financial statements can only show measurable
activities of a corporation such as its quantifiable resources, its liability, amount of taxes
it is facing, etc.
Assumption 4: Periodicity - ANS Companies are required to file annual and interim
reports
In the US, quarterly and annual financial reports are required
An accounting year (fiscal year) is frequently aligned with the calendar year
Four Underlying Assumptions of Accounting - ANS (1) Accounting Entity
(2) Going Concern
(3) Measurement
(4) Periodicity
Principle 1: Historical Cost - ANS Financial statements report companies' resources at
an initial historical cost
Why?
Represents the easiest measurement method without a need for appraisal and
revaluation
Marking resources up to fair value allows for management discretion and subjectivity,
which US GAAP attempts to minimize by using historical cost
Note: IFRS allows you to write up the asset to fair value, but most companies use
historical value anyways
Principles 2 and 3: Accrual Accounting (Revenue Recognition and Matching Principle) -
ANS Governs the company's timing in recording its revenues (i.e. sales) and associated
expenses
2) Revenue Recognition: Accrual basis of accounting dictates that revenues must be
recorded when earned and measurable
3) Matching Principle: Under the matching principle, costs associated with making a
product must be recorded during the same period as revenue generated from that
product
Exercise Answer: 1) 1/4/15; 2) 1/4/15
Why can't companies immediately record these revenues and expenses? - ANS
According to the revenue recognition principle, a company cannot record revenue until
, that order is shipped to a customer (only then, is the revenue actually earned) and
collection from that customer is reasonably assured
Why shouldn't a company record an expense when it actually buys the item? - ANS
According to the matching principle, costs associated with the production of the product
should be recorded in the same period as the revenue from the product's sale
US GAAP vs. IFRS Accrual Accounting - ANS
Principle 4: Full Disclosure - ANS Companies must reveal all relevant economic
information that they determine to make a difference to its users
Such disclosure should be accomplished in the following sections of companies' reports:
(1) Financial statements
(2) Notes to financial statements
(3) Supplementary information
Four Underlying Principles in Accounting - ANS (1) Historical Cost
(2) Accrual Accounting: Revenue Recognition
(3) Accrual Accounting: Matching Principle
(4) Full Disclosure
Constraint 1: Estimates & Judgments - ANS Certain measurements cannot be
performed completely accurately, and must therefore utilize conservative estimates and
judgments
Constraint 2: Materiality - ANS Inclusion and disclosure of financial transactions in
financial statements hinge on their size and effect on the company performing them
Note: Materiality varies across different entities
Constraint 3: Consistency - ANS Each company has to prepare financial statements
using measurement techniques and assumptions which are consistent from one period
to another
Constraint 4: Conservatism - ANS Financial statements should be prepared with a
downward measurement bias
Assets and revenues should not be overstated, while liabilities and expenses should not
be understated
Four Underlying Constraints in Accounting - ANS (1) Estimates & judgments
(2) Materiality
(3) Consistency
(4) Conservatism
Summary of Accounting Assumptions, Principles, Constraints - ANS Most important are
the historical cost, revenue recognition, and matching principles
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