Accounting Principles and Financial Statements (Portfolio 5116)

Bloomberg BNA Tax and Accounting Portfolio 5116-2nd, Accounting Principles and Financial Statements (Accounting Policy and Practice Series), explains the basic concepts underlying financial accounting and the elements of financial statements prepared under U.S. generally accepted accounting principles (GAAP). 

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Bloomberg BNA Tax and Accounting Portfolio 5116-2nd, Accounting Principles and Financial Statements (Accounting Policy and Practice Series), explains the basic concepts underlying financial accounting and the elements of financial statements prepared under U.S. generally accepted accounting principles (GAAP). For the financial and credit markets to operate effectively, companies must provide reliable information about their financial results and conditions to external parties, such as existing and potential shareholders, existing and potential creditors, and governmental agencies. To ensure that companies provide reliable information, standard setters established numerous principles for financial accounting, although companies have significant discretion in how they apply many of these principles. Thus, to properly interpret financial statements, financial statement users and their advisors must understand the principles and the choices companies may make in applying the principles.
The primary standard-setter for financial accounting is the Financial Accounting Standards Board (FASB), whose goal is to establish and improve standards of financial accounting and reporting for nongovernmental entities. Since 2009, FASB maintains the FASB Accounting Standards Codification (Accounting Standards Codification) which represents the source of authoritative standards of accounting and reporting, other than those issued by the SEC, to be applied by nongovernmental entities. Other U.S. standard-setters include such as the American Institute of Public Accountants (AICPA) and the Securities and Exchange Commission (SEC), the American Institute of Public Accountants (AICPA), and the Public Company Accounting Oversight Board also provide specific accounting guidance on select issues.
In the U.S., the main financial statements are the balance sheet (which conveys a company's financial condition on a given date), the income statement (which conveys a company's financial results within a given period), the statement of cash flows (which conveys a company's liquidity situation).
There are many issues involved in compiling the income statement, balance sheet, and cash flow statement. The threshold issue is how much revenue to recognize during the accounting period. This issue is rather straightforward under the cash method of accounting—a company recognizes revenues only when it receives cash. Most companies, however, must use the accrual method of accounting, which essentially requires that these companies recognize income when they complete a transaction even though they might not collect cash from the transaction until a later date, if at all. This recognition rule has complicated issues that are discussed in this Portfolio. For more information on revenue recognition see APP 5100-2nd, Revenue Recognition: Fundamental Principles (Accounting Policy and Practice Series).
Several complex issues regarding expenses and accounting for inventory and long-term assets are discussed in this Portfolio. Lastly, this Portfolio discusses the methods accounting professionals and financial analysts use to analyze financial statements, including computing various ratios from financial statement data. By understanding these ratios, financial statement users can better assess the strengths and weaknesses of a company's financial position.
This Portfolio is intended to be an overview of the concepts underlying U.S. GAAP. It may be cited as Bloomberg BNA Tax and Accounting Portfolio 5116-2nd, Robinson & Marmorstein, Accounting Principles and Financial Statements (Accounting Policy and Practice Series).


Thomas R. Robinson, Ph.D., CPA, CFP,® CFA®

Thomas R. (“Tom”) Robinson is Managing Director of the Educational Division of the CFA Institute. He leads and develops the teams responsible for producing and delivering educational content to candidates, members, and others encompassing CFA Program Content, Professional Development Content, Private Wealth, Publications, University Relations, and Conferences. Previously, Tom was an Associate Professor of Accounting and Director of the Master of Professional Accounting program at the University of Miami. He also was Managing Director of TR Robinson & Associates, LLC, a state registered Investment Advisory firm. He primarily taught financial statement analysis, personal financial planning, and valuation. He has a B.A. in Economics from the University of Pennsylvania, and a Masters and Ph.D. from Case Western Reserve University. Tom is a certified public accountant (Ohio), certified financial planner® (CFP®) and chartered financial analyst® (CFA®). Prior to joining the University of Miami, Tom practiced public accounting and financial planning for 10 years, primarily with Deloitte & Touche and Pritchett Dlusky & Saxe in Columbus, Ohio. He has also served as a consultant to law firms, accounting firms, professional associations, and governmental agencies in the areas of financial statement analysis and valuation.

Howard Marmorstein, Ph.D.

Howard Marmorstein is an Associate Professor of Marketing at the University of Miami where he teaches Marketing Management and Consumer Behavior. Professor Marmorstein received both a B.S. in Economics and an M.B.A. from the Wharton School of the University of Pennsylvania. He received his Ph.D. from the University of Florida. He has served as an Investment Adviser for more than 10 years. Professor Marmorstein won the University of Miami Professor of the Year Award in 2003. His research on consumer decision making has won two national awards and has been published in numerous academic journals. Professor Marmorstein has also served as an expert witness and business consultant for both firms and municipalities in the areas of business valuation, eminent domain, trademark infringement, and deceptive advertising.

Table of Contents

Detailed Analysis

I. U.S. GAAP - Introduction

Introductory Material

A. Need for Accounting

1. External Reporting

2. Internal Reporting

B. Financial Accounting

1. Need for Principles (Standards)

2. U.S. Generally Accepted Accounting Principles

a. Objectives of Financial Reporting by Business Enterprises

b. Objectives of Financial Reporting by Nonbusiness Enterprises

c. Financial Statements

3. Historical Development of Principles

4. Current GAAP Hierarchy

C. Auditing Standards

1. Generally Accepted Auditing Standards

2. Audit Opinions

a. Unqualified Opinion

b. Qualified Opinion

c. Adverse Opinion

d. Disclaimer of Opinion

3. The Sarbanes-Oxley Act and the Public Company Accounting Oversight Board

II. U.S. GAAP - Accounting Concepts and Financial Statements

Introductory Material

A. Accounting Periods and Methods

1. Fiscal Periods

2. Accrual Basis Versus Cash Basis of Accounting

B. Qualitative Characteristics of Accounting Information

1. Relevance and Reliability

2. Comparability and Consistency

3. Materiality

4. Costs and Benefits

5. Understandability

C. Accounting Concepts

1. Elements of Financial Statements

2. Articulation

3. Accruals

4. Deferrals

5. Realization Versus Recognition

6. Separate Entity

7. Conservatism

8. Objectivity

9. Going Concern

10. Stable Monetary Unit

D. Primary Financial Statements

1. The Balance Sheet

a. Assets

(1) Current Assets

(2) Non-Current Assets

b. Claims

(1) Current Liabilities

(2) Non-Current Liabilities

(3) Owners' (Shareholders') Equity

2. The Income Statement

3. Statement of Cash Flows

III. U.S. GAAP - Accounting Systems and Records

Introductory Material

A. Recording Transactions

1. Systematic Recording of Transactions

2. Double-Entry Accounting

3. The Accounting Process

a. Recording Transactions

b. Posting Transactions

c. Trial Balance

d. Adjusting Entries

e. Adjusted Trial Balance

f. Trial Balance Worksheet

g. Preparation of Financial Statements

h. The Closing Process

i. Post Closing Trial Balance

4. Special Journals and Subsidiary Ledger

IV. U.S. GAAP - Revenue Recognition and Related Balance Sheet Accounts

Introductory Material

A. Revenue Recognition in General

1. ARB 43

2. APB 10

3. CON 5

a. Realized or Realizable

b. Earned

4. FAS 48

5. FAS 11

6. SAB 101

7. Financial Statement Presentation

B. Special Cases

1. Separately Priced Warranty Contracts

2. Sale or Cash Receipt Occurs Prior to Production

3. Recognition of Revenue by the Passage of Time

4. Gross Versus Net Reporting

5. Installment Sales

a. Installment Method

b. Cost Recovery Method

6. Advertising Barter Transactions

7. Commodities

8. Long-Term Contracts

9. Sales Type Leases

a. General Criteria

b. Additional Criteria

V. U.S. GAAP - Cost of Goods Sold and Inventory

Introductory Material

A. Inventory Accounting Concepts and Terminology

1. Accounting Systems

2. The Inventory Equation

3. Inventory Cost-Flow Assumptions

a. First-In, First-Out (FIFO)

b. Last-In, First-Out (LIFO)

c. Weighted Average Method

d. Specific Identification

B. Importance of Accounting for Inventory: Implications for the Income Statement and Balance Sheet

C. Inventory Accounting Differences by Type of Business Entity

1. Distribution Companies

2. Manufacturers

a. Raw Materials

b. Work in Process (WIP)

c. Finished Goods

D. Specialized Methods

1. The Gross Profit Method

2. The Retail Method

E. Changes in the Value of Inventory

1. Lower of Cost or Market Rule

2. Market Value

VI. U.S. GAAP - Depreciation, Amortization, and Long-Term Assets

Introductory Material

A. Categories of Long-Term Assets

1. Tangible Assets

2. Intangible Assets

B. Recording the Initial Cost of Long-Term Assets

1. Purchased and Self-Constructed Assets in General

a. Tangible Assets

b. Intangible Assets

(1) Specifically Identifiable Intangibles

(2) Goodwill

2. Basket Purchases

3. Capitalization of Interest Cost

C. Depreciation of Tangible Assets

1. Time-Based Methods

a. Straight-Line Depreciation

b. Accelerated Methods

(1) Sum-of-the Years-Digit Method (SYD)

(2) Declining Balance Method (DB)

2. Activity Method

D. Amortization of Intangible Assets

1. Specifically Identifiable Intangibles

2. Goodwill

E. Impairment

1. Tangible Assets

2. Intangible Assets

F. Post-Acquisition Costs of Long-Term Assets

1. Repairs and Maintenance

2. Improvements

VII. U.S. GAAP - Operating Expenses, Related Assets, and Liabilities

Introductory Material

A. General Principles

1. Matching

2. Allocation

3. Period Incurred

B. Prepaid Assets and Accrued Liabilities

1. Prepaid Expenses/Assets

2. Accrued Expenses/Liabilities

C. Specific Operating Expenses

1. Advertising

2. Research and Development Expenses

3. Uncollectible Accounts

4. Leases

5. Compensation Expense

a. Compensation and Benefits Paid in Cash

b. Benefits Paid in Stock or Stock Options

c. Pension Expense and Other Post-Retirement Benefits

6. Taxes Other Than Income Taxes

VIII. U.S. GAAP - Interest Expense and Related Liabilities

Introductory Material

A. Short-Term Obligations

1. Accounts Payable

2. Short-Term Notes Payable-Interest Bearing

3. Short-Term Notes Payable-Non-Interest Bearing

B. Long-Term Obligations

1. Long-Term Notes Payable

2. Mortgages

3. Bonds Payable

a. Bonds Sold at Face Value

b. Bonds Sold at a Discount

c. Bonds Sold at a Premium

IX. U.S. GAAP - Non-Operating Income and Investments

Introductory Material

A. Investments in Securities

1. Investments in Debt Securities

2. Investments in Equity Securities

a. Cost Method

b. Equity Method

c. Consolidation Method

B. Other Asset-Related Gains and Losses

C. Liability Related Gains and Losses

D. Unusual or Infrequent Items

X. U.S. GAAP - Income Taxes

Introductory Material

A. Tax Versus GAAP

1. Permanent Differences

2. Temporary Differences

B. Extended Deferred Tax Liability Example

C. Extended Deferred Tax Asset Example

D. Common GAAP/Tax Differences

E. Accounting for Uncertainties in Income Taxes

XI. U.S. GAAP - Net Income, Special Items, and Earnings Per Share

Introductory Material

A. Net Income Before Special Items

B. Discontinued Operations

C. Extraordinary Items

D. Earnings Per Share

1. Basic Earnings Per Share

2. Diluted Earnings Per Share

XII. U.S. GAAP - Understanding the Income Statement and Comprehensive Income

Introductory Material

A. Reading an Income Statement

1. Accounting Periods and Methods

2. Revenues

3. Costs and Expenses

4. Operating Profit

5. Interest

6. Income Before Taxes

7. Provision for Income Taxes

8. Income Before Minority Interest

9. Minority Interest

10. Net Income and Earnings Per Share

B. Comprehensive Income

XIII. U.S. GAAP - Understanding the Balance Sheet and Statement of Owners' Equity

Introductory Material

A. Reading a Balance Sheet

1. Assets = Liabilities + Owners' Equity

2. Assets

a. Cash and Cash Equivalents

b. Receivables

c. Inventories

d. Prepaid Expenses and Other Future Expenses

e. Total Current Assets

f. Property, Plant, and Equipment

g. Property Under Capital Lease

h. Goodwill

i. Other Assets and Deferred Charges

3. Liabilities

a. Commercial Paper

b. Accounts Payable

c. Accrued Liabilities

d. Accrued Income Taxes

e. Long-Term Debt Due Within One Year

f. Total Current Liabilities

g. Long-Term Debt

h. Deferred Income Taxes and Other Long-Term Liabilities

i. Minority Interests

4. Owners' Equity

a. Preferred Stock

b. Common Stock and Capital in Excess of Par Value

c. Retained Earnings

d. Other Comprehensive

5. Overall Balance Sheet Analysis

B. Statement of Owners' Equity

XIV. U.S. GAAP - Understanding the Statement of Cash Flows

Introductory Material

A. The Statement of Cash Flows Format

1. Operating Cash Flows

2. Investing Cash Flow

3. Financing Cash Flow

4. Overall Cash Flow

5. Free Cash Flow (FCF)

B. Evaluating a Cash Flow Statement

1. Overall Cash Flow

2. Categories of Cash Flow

3. Operating Cash Flow

4. Investing Cash Flow

5. Financing Cash Flow

6. Overall Evaluation

XV. U.S. GAAP - Financial Statement Analysis

Introductory Material

A. Comparisons to Benchmarks

1. Markets

2. Industries

3. Peer Companies

B. Ratio Analysis

1. Efficiency Ratios

a. Inventory Turnover

b. Receivables Turnover

c. Payables Turnover

d. Fixed Asset Turnover

e. Total Asset Turnover

2. Liquidity

a. The Operating Cycle

b. The Cash Cycle

c. The Current Ratio

d. The Cash Flow From Operations Ratio

3. Solvency

a. Debt to Total Capital Ratio

b. Times Interest Earned Ratio

c. Capital Expenditures Ratio

4. Profitability

a. Gross Profit Margin

b. Operating Margin

c. Net Margin

d. Return on Assets

e. Return on Equity

5. Valuation

a. Price to Earnings (P/E) Ratio

b. Price to Book (P/B) Ratio

C. Common Size Analysis

1. Vertical Analysis

a. Vertical Analysis: Income Statement

b. Vertical Analysis: Balance Sheet

2. Horizontal Analysis

a. Horizontal Analysis: Income Statement

b. Horizontal Analysis: Balance Sheet

3. Common Size Analysis: Cash Flow Statement

D. Segment Reporting and Evaluation

XVI. IFRS - Introduction

A. Historical Background of the IASB and IFRS

B. Authoritative Guidance Under IFRS

1. IFRS Hierarchy

2. IASB Framework

C. Particulars of IFRS

1. Principles-Based

2. Format of IFRS

D. Who Uses IFRS

E. Adoption of IFRS

1. Plan for IFRS

2. Choose an Approach: Minimize Differences or Fresh Start/Clean Sheet

3. Plan the Transition

4. First-Time Adoption - IFRS 1 Considerations

XVII. IFRS - Accounting Concepts and Financial Statements

A. Objectives of Financial Reporting Under IFRS

B. Qualitative Characteristics of Financial Statements

1. Understandability

2. Relevance

a. Nature of Information

b. Materiality

3. Reliability

4. Comparability

5. Constraints on Relevant and Reliable Information

C. Accounting Concepts

1. Elements of Financial Statements

2. Recognition

3. Underlying Assumptions (Accrual Basis and Going Concern)

D. Financial Statements

1. Statement of Financial Position

a. Assets

b. Liabilities

c. Equity

2. Statement of Comprehensive Income

3. Statement of Changes in Equity

4. Statement of Cash Flows

5. Notes to the Financial Statements

XVIII. IFRS - Revenue Recognition

A. In General

B. Categories of Revenue

C. Significant Deviations From U.S. GAAP

XIX. IFRS - Depreciation, Amortization, and Long-Term Assets

A. PP& E

1. Measurement at Cost

2. Depreciation

3. Significant Deviations From U.S. GAAP

B. Intangible Assets

1. In General

2. Significant Deviations From U.S. GAAP

XX. IFRS - Expenses

A. Cost of Goods Sold and Inventory

1. In General

2. Significant Deviations From U.S. GAAP

B. Operating Expenses, Related Assets, and Liabilities

1. General Principles: Matching, Allocation, Period Incurred

2. Prepaid Assets and Accrued Liabilities

3. Specific Operating Expenses

a. Advertising

b. Research and Development Expenses

c. Uncollectible Accounts

d. Leases

e. Compensation Expense

f. Taxes Other Than Income Taxes

C. Interest Expense and Related Liabilities

XXI. IFRS - Income Taxes

Introductory Material

A. Current Tax Expense

B. Deferred Tax Assets and Liabilities

C. Significant Deviations From U.S. GAAP

XXII. IFRS - Investment Property

A. In General

B. Investment Property Issues

1. Dual Use/Multipurpose Property

2. Services Provided to Occupants of Property

C. Recognition and Measurement of Investment Property

Working Papers

Working Papers


Worksheet 1 Glossary

Worksheet 2 Violation of Accounting Principles in the Real World-WorldCom Inc.

Worksheet 3 Hierarchy of U.S. Generally Accepted Accounting Principles

Worksheet 4 Qualitative Characteristics of Accounting Information

Worksheet 5 Independent Auditor's Report: Unqualified Opinion

Worksheet 6 Independent Auditor's Report: Qualified Opinion

Worksheet 7 Independent Auditor's Report: Adverse Opinion

Worksheet 8 Independent Auditor's Report: Disclaimer of Opinion

Worksheet 9 Grant's PCs Example

Worksheet 10 Example Cash-Based Versus Accrual-Based Measures of Performance-Grant's PCs

Worksheet 11 SEC Staff Accounting Bulletin: No. 99, Materiality

Worksheet 12 Wal-Mart Stores, Inc. Consolidated Balance Sheets

Worksheet 13 Wal-Mart Vertical Common Size Balance Sheets

Worksheet 14 Wal-Mart Horizontal Common Size Balance Sheets (Percentage Change From Prior Year)

Worksheet 15 Wal-Mart Stores, Inc. Consolidated Statements of Income

Worksheet 16 Wal-Mart Vertical Common Size Income Statements

Worksheet 17 Wal-Mart Horizontal Common Size Income Statements (Percentage Change From Prior Year)

Worksheet 18 Wal-Mart Other Accumulated Comprehensive Income, Annual Report, Footnote 4

Worksheet 19 Wal-Mart Consolidated Statements of Cash Flows

Worksheet 20 Wal-Mart Statements of Cash Flows (Indirect Method)

Worksheet 21 Wal-Mart Common Size Cash Flow Statement (as a Percentage of Sales)

Worksheet 22 Wal-Mart Statement of Stockholders' Equity

Worksheet 23 Footnote 1 to Wal-Mart Financial Statements

Worksheet 24 Wal-Mart Segment Data Disclosure, Annual Report (Footnote 11)

Worksheet 25 Wal-Mart Common Size Segment Data

Worksheet 26 ABC Imports, Inc., Summary of Transactions

Worksheet 27 ABC Imports, Inc. Illustration of Double Entry Accounting System General Ledger Accounts

Worksheet 28 ABC Imports, Inc. Journal Entries

Worksheet 29 ABC Imports, Inc. Trial Balance Worksheet

Worksheet 30 ABC Imports, Inc. General Ledger Accounting After Closing

Worksheet 31 SEC Staff Accounting Bulletin: No. 101, Revenue Recognition in Financial Statements

Worksheet 32 SEC Staff Accounting Bulletin: No. 101A, Amendment: Revenue Recognition in Financial Statements

Worksheet 33 SEC Staff Accounting Bulletin No. 101B, Second Amendment: Revenue Recognition in Financial Statements

Worksheet 34 Office of the Chief Accountant: Staff Accounting Bulletin No. 101: Revenue Recognition in Financial Statements-Frequently Asked Questions and Answers

Worksheet 35 Example FIFO Versus LIFO Inventory-XYZ Paper

Worksheet 36 Example Weighted Average Inventory-XYZ Paper

Worksheet 37 Example Multi-Year Inventory Computations-XYZ Paper

Worksheet 38 Example Capitalization of Interest Cost-ABC Manufacturing

Worksheet 39 Example Effect of Lease Classification on Financial Ratios-XYZ Corp.

Worksheet 40 Example The Time Value of Money: Concepts, Formulas, and Examples

Worksheet 41 Future Value Table Future Amount of $1.00

Worksheet 42 Present Value Table

Worksheet 43 Present Value of an Ordinary Annuity Table

Worksheet 44 Example Recognition of Income From Trading Securities-Xena Co.

Worksheet 45 Example Accounting for Unrealized Changes in Available for Sale Securities: Income Statement and Balance Sheet Effect-Zeta Co.

Worksheet 46 Example Accounting for Investments in Securities When the Equity Method Applies Due to Influence Over the Investee: Income Statement and Balance Sheet Effect-Arrow Co.

Worksheet 47 Example Income From Investment Under the Consolidation Method: Comparison to Equity Method-Arrow Co.

Worksheet 48 Walt Disney Company Partial Income Statement

Worksheet 49 Cree, Inc. 1999 Annual Report Form 10K, Footnote 9

Worksheet 50 Example Converting Indirect Operating Cash Flow to Direct Operating Cash Flow- ABC Imports, Inc.

Worksheet 51 Computing Income Tax Expense-Using Actual Taxes v. Expected Taxes

Worksheet 52 Abbreviated Income Statement Presentation With Three Types of Special Items




Securities and Exchange Commission:

Staff Accounting Bulletins

SEC Concept Releases

SEC Proposals

SEC Rules

Public Company Accounting Oversight Board:

Interim Standards


American Institute of Certified Public Accountants:

Accounting Principles Board Opinions

Accounting Research Bulletins

Audit and Accounting Guides

Code of Professional Conduct

Statements on Auditing Standards

Statement on Auditing Standard (Codified)

Statements of Position

Emerging Issues Task Force

Financial Accounting Standards Board:

Concepts Statements

Statements of Financial Accounting Standards


Technical Bulletins

International Accounting Standards Board:

International Accounting Standards

International Financial Reporting Standards

Standing Interpretations Committee Interpretations




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