1A.

Basic Concepts

For the private sector For state and local governments

SEC designates SEC issues SEC designates

FASB to develop GAAP. additional GAAP for public GASB to develop GAAP.
companies.

GAAP for for-profits GAAP for not-for-profits GAAP for public companies GAAP for state and local
is recorded in is recorded in is recorded in governments is recorded in

ASC. ASC. ASC, CFR, SEC staff guidance. GASB Codification.

● All chapters deal with private sector for-profit accounting, shown in the first columns above, unless stated otherwise.
● Since a college or hospital could be any of the above—private for-profit, private not-for-profit, public, or state/local government—the exam
question will specify.

GAAP ​The body of accounting rules that is recognized as authoritative by SEC and AICPA. It includes the ASC, GASB codification, and the SEC rules
and regulations found in the Code of Federal Regulations (CFR).

Accounting Standards Codification (ASC) ​The source document for all private-sector GAAP, except that which is published by the SEC. There is no
hierarchy within ASC; it all carries an equal level of authority. As a service to users, the ASC includes some SEC rules, but the rule as written by the
SEC is authoritative for public companies.

● The following is not GAAP: Statements of Financial Accounting Concepts, IFRS, widely recognized industry practices, AICPA Issues Papers,
pronouncements of professional associations and regulatory agencies.

Statements of Financial Accounting Concepts ​Informs GAAP concepts without the force of GAAP.
Objective of ● To provide information useful to existing and potential investors, lenders, and creditors.
reporting

Scope of ● Information benefits must exceed costs of providing information, else not reported.
reporting ● Information must be material in that omission could influence a user’s decision, else not reported.

Qualitative Fundamental characteristics Enhancing​ ​characteristics ​Enhances both relevance and

characteristics ● Rele​va​nce faithful representation.
of reporting ○ Predictive ​va​lue ● Comparability​ One company to another.
○ Confirmatory ​va​lue ● Verifiability
● Faithful representation ● Timeliness​ Downside of reporting too often is less
○ Complete faithful representation.
○ Neutral ● Understandability
○ Free from error

Elements ● Revenue (expense)​ Increase (decrease) in assets or decrease (increase) in liabilities from central operations.
● Gain (loss)​ Increase (decrease) in assets or decrease (increase) in liabilities from peripheral operations.
● Other comprehensive income​ Change in equity from nonowner sources.
● Asset​ The result of a past transaction, owned today, a benefit in the future.
● Liability ​The result of a past transaction, owed today, a sacrifice in the future.
● Equity​ Owners’ residual interest. Assets less liabilities.
● Investment by owner (distribution to owner)​ Owner contribution to (withdrawal from) the company.

◯ For other comprehensive income, SFAC definition is different from GAAP definition (see Chapter 1C for GAAP definition).

Concepts ● Conservatism​ Don’t overstate assets or net income.

● Matching​ Apply expense to revenue in period revenue accrued. ex. Co. applies commission expense to month of sale, not
month of payment to employees.
● Historical cost ​Most assets and liabilities are reported on basis of acquisition price because it is faithfully representative. But
departure from historical cost is allowed when another measurement is more conservative (e.g. fair value is used for
inventory, impairments) or more representative (e.g. present value of cash flows is used for long-term assets and liabilities).
● Accrual ​Initial journal entry is adjusting entry on Balance Sheet date. Cash entry comes later.
● Deferral​ Initial journal entry is for cash. Adjusting entry comes later on Balance Sheet date.
● Financial capital maintenance​ GAAP. Aim to maintain purchasing power. ex. Buy 10; sell 15; current cost 12; gain 5.
● Physical capital maintenance​ Not GAAP. Aim to maintain operating capacity. ex. Buy 10; sell 15; current cost 12; gain 3.

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 Current asset Current liability

Asset that is cash, and asset that will be converted to cash or expended Liability that is expected to require current asset, is usually payable within
within one year. one year.

Monetary asset (liability) Nonmonetary asset (liability)

● Claim to receive (obligation to pay) ​cash​ in amounts fixed or
determinable without reference to future prices.
● Claim to receive (obligation to pay) ​cash​ in amounts dependent on
future prices.
● Goods​ held primarily for resale or direct use (obligations to furnish
goods or services​, even in amounts fixed or determinable without
reference to future prices).
● Residual rights such as goodwill or equity interests.

◯ For list of monetary accounts vs. nonmonetary accounts, see ​http://www.fasb.org/pdf/aop_FAS89.pdf​.

Installment sale ​Used in limited cases when collection of the sale price is not reasonably assured. Given these gross profit (GP) formulas, record an
installment sale.

— GP = Sales - Cost of goods sold

— GP% = GP / Sales
— Cumulative realized GP = Collections * GP%
— Cumulative deferred GP = AR * GP%

Event Journal entry

1/1 Co. records $20,000 sale. dr. Installment AR 20,000

cr. Installment sales 20,000

1/1 Co. records $15,000 cost of sales. dr. Cost of goods sold 15,000
cr. Inventory 15,000

5/10 Co. records $10,000 collections. dr. Cash 10,000

cr. Installment AR 10,000

12/31 Co. defers all gross profit. dr. Installment sales 20,000
cr. Cost of goods sold 15,000
cr. Deferred gross profit 5,000

12/31 Co. recognizes portion of deferred profit. dr. Deferred gross profit 2,500
cr. Realized gross profit 2,500

◯ Interest income is calculated independently and is recognized in full. Total current revenue = Realized gross profit + Interest income. ◯ Deferred
gross profit is reported as a contra receivable.

Other accounting methods

Cost recovery Used in rare cases when uncertainty of collection is even greater than that of installment sales.
● Defer all gross profit.
● Do not recognize any part of deferred profit until total collection (principal ​and interest​) exceeds cost of sales.

Multiple-deliverable
revenue arrangement
Each deliverable is treated as a separate unit of accounting, recognized separately. ​ex. Phone company sells
smartphone at discount to customer who signs up for two year contract. To qualify, ​both of the following are needed:
● Delivered item has stand-alone value.
● In cases where there is a general right of return, delivery of the undelivered item (ex. Smartphone) is probable
and substantially in the control of the vendor.

Milestone For vendors that perform research and development services. Contingent revenue is recognized when substantive
milestone is achieved—not when payment is collected.

Franchise agreement Basically accrual except revenue is recognized “upon substantial performance” instead of “earnings process complete.”

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Convert from accrual basis to cash basis
Fake cash method 1. Record changes in income statement account.
2. Record changes in related balance sheet accounts.
3. Solve for cash account.

◯ See Chapter 9 for table of related balance sheet accounts.

ex. Co. keeps books on accrual basis. On 12/31/1, AP is $75,000 and inventory is $290,000. On 12/31/2, AP is $50,000 and inventory of $260,000.
During Year 2, Co. has cost of goods sold of $545,000. Find Year 2 cash paid to suppliers.

— 1. Debit COGS by $545,000 because COGS increases and it is normal debit. 2. Credit AP by $30,000 because AP increases and it is normal credit.
Credit inventory by $30,000 because inventory decreases and it is normal debit. 3. Cash paid to suppliers is $540,000.

dr. COGS 545,000

dr. AP 25,000
cr. Inventory 30,000
cr. Cash X

Convert from cash basis to accrual basis

Fake cash method 1. Record changes in cash account.
2. Record changes in related balance sheet accounts.
3. Solve for income statement account.

ex. Co. keeps books on cash basis. On 12/31/1, AR is $40,000, and unearned fees is $10,000. On 12/31/2, AR is $60,000, and unearned fees is $5,000.
During Year 2, Co. collects $200,000 from clients. Find Year 2 revenue on accrual basis.

— ​Use the fake cash method​: 1. Debit cash by $200,000 because cash increases during Year 2 and it is normal debit. 2. Debit AR by 20,000 because
AR increases and it is normal debit balance. Debit unearned fees by $5,000 because unearned fees decreases and it is normal credit. 3. Revenue on
accrual basis is $225,000.

dr. Cash 200,000

dr. AR 20,000
dr. Unearned fees 5,000
cr. Revenue X

GAAP vs. IFRS GAAP IFRS

The term ​Revenue ​(​Expense​) refers to increase The term ​Income ​(​Expense​) refers to increase (decrease)
(decrease) in equity from central ops. in equity from central ops and peripheral ops.

GAAP uses the term ​Net income​. IFRS uses the term ​Profit​.