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The Industrial Revolution Absentee Ownership of Business

16th Amendment Income Tax and Uniform Financial Reporting


Stock Market Crash of 1929 Creation of SEC
Financial Accounting Standards Board Creation (1973) GAAP
Sarbanes-Oxley Requirement of Audit of Internal Controls, Creation of PCAOB
Financial Capital Maintenance (GAAP) profit = $from sale - $to acquire sold items
Physical Capital Maintenance profit = $from sale - $to replace sold items
Products that are shipped may not be counted as revenue. Revenue may not be recognized
if the products are returnable any of the following are true.
The buyer doesnt pay at time of sale and doesnt have the obligation to pay on
a specified date.
The buyer has a date that it has to pay BUT obligation to pay is excused until
resale or consumption.
The seller would forgive payment in the event of theft or destruction of
products (risk still on seller).
They buyer acquiring the product does not have economic substance apart from
that provided by the seller.
The seller has significant obligations for future performance to directly bring
about resale.
There are also circumstances where delivery isnt considered to be completed. The
following criteria outline when delivery is recognized when it hasnt really happened.
The risk of ownership has passed to the buyer.
The customer has a fixed commitment to purchase the goods.
The buyer must request the bill-and-hold agreement.
There is a fixed schedule for delivery. The date must be reasonable and
consistent with the businesss purposes.
The seller must not have any more performance obligations.
The ordered goods must be segregated from the sellers inventory and not be
available for other orders.
The product must be complete and ready for shipment.
CIP = total gross profit = construction in progress x (profit at end total costs) + costs
incurred to date

1. Cost of adopting standard < benefit of adopting standard


- Benefits of disclosing information: Publicly traded companies must provide
information to comply with SEC reporting requirements (private companies not
subject to SEC oversight)
- Disclosing information reduces investors uncertainty about firms opportunities
and risk and reduce firms cost of capital securities have higher market price
- Attract employees, customers, suppliers
- Lack of disclosure might make others think undisclosed info is unfavorable
Costs of disclosing information: Collecting, processing, distributing info costly
- Competitors can obtain info and use it to disclose firms disadvantage
- Release of certain types of information (i.e. exec compensation) results in scrutiny
- Chance of giving wrong info increases w/ quantity of info released litigation risk
2. Relevance: reported financial info should be able to influence decisions of users of info;
reported info could have predictive value or confirmatory value and be timely in nature
3. Faithful representation (reliability): info complete, neutral, free from material error
4. Comparability: info should be measured & reported so users of info may make
meaningful comparisons of different companies
5. Consistency: same accounting methods should be used to measure similar transactions
& events from period to period

Closing entries used to update Retained Earnings account and to reset Revenue, Expense,
Dividend, Gain, and Loss accts to 0
1. Debit each revenue/gain account in amount of credit balance to close them; temporary
Income summary is credited in same amount
2. All expense & loss accts closed by crediting expense/loss acct in amount of debit
balance and debiting temporary Income Summary acct
3. Income summary acct closed to Retained Earnings; if income summary has debit
balance, income summary is credited and retained earnings is debited and vice versa
4. Dividend acct closed by crediting in amount of debit balance and debiting RE

1. Economic entity: entity which is providing info should be well defined; Inter alia,
should be clear what entities have or have not been consolidated
2. Going concern assumption: firm will remain in business unless something suggests
otherwise (certain methods i.e. depreciating an asset over time) not appropriate when this
assumption is violated
3. Monetary unit assumption: info should be expressed in monetary terms
4. Periodicity: economic activities of firm are divided into time periods
5. Objectivity: ability of independent party to verify financial statements of firm is deemed
important in accounting
6. Conservatism: when uncertainty exists, unfavorable outcome is reflected in financial
statements immediately whereas favorable outcome is deferred until it occurs
7. Materiality: accounting treatment for relatively minor items dont matter (those which
do not influence decisions made by readers of financial statements); magnitude w/o regard
to nature of item will not be sufficient basis for materiality judgment
8. Revenue recognition principle: a) revenue has been earned; b) revenue is
realized/realizable (when resources are received or realizable when resources to be
received are readily convertible into some other asset)
9. Matching concept: firm records expenses such that resources used in getting those
revenues are deducted in calculation of Net Income in same acct period as related revenues
are recognized

Percentage of completion method: revenue recognized each accounting period over life of
contract; no revenue recognized until contract actually complete; conditions:
- contract clearly specifies enforceable rights regarding goods & services to be provided
and received by parties, consideration to b exchanged, and manner and terms of settlement

Investments by owners: increases in net assets of particular enterprise resulting from


transfers to it from other entities of something of value to obtain or increase ownership
interests (or equity) in it; assets commonly received as investments by owners but
Statement of Comprehensive Income includes all changes to equity except investments
and distributions pertaining to owners. It is net income and other things (change in security
value, foreign currency adjustment, pension plan changes, etc.).
- Notes to financial statements: contain set of notes with important info about accounting
methods used in preparing financial statements, additional detail related to numbers in
statements, and other info not required within financial statements
- US GAAP: framework US corporations follow when compiling financial statements for
financial reporting purposes
- Auditors opinion: report issued by independent public accountant indicating accountant
has audited financial statements; auditors face pressures b/c audit market is competitive
and they may feel compelled to agree w/ client to retain client; in addition to audit opinion,
subject to passage of Sarbanes-Oxley Act, firms auditor is required to express opinion on
managements assessment of internal controls
- Notes to financial statements: contain set of notes with important info about accounting
methods used in preparing financial statements, additional detail related to numbers in
statements, and other info not required within financial statements
- US GAAP: framework US corporations follow when compiling financial statements for
financial reporting purposes
- Auditors opinion: report issued by independent public accountant indicating accountant
has audited financial statements; auditors face pressures b/c audit market is competitive
and they may feel compelled to agree w/ client to retain client; in addition to audit opinion,
subject to passage of Sarbanes-Oxley Act, firms auditor is required to express opinion on
managements assessment of internal controls

Reversing entries facilitate recording transactions later in accounting period


Subsidiary ledgers/journals keep track of detailed information i.e. Purchases journal
- purchases journal/ledger could be closed to COGS or Inventory
Long-term construction contracts = overlap multiple accounting periods; firms take
actions that continuously move them closer and closer to completion of project issue is
when revenue should be spread over life of product or recognized in entirety when project
is completed

- buyer can be expected to satisfy all obligations under contract


- contractor can be expected to perform contractual obligation
% completed = (cumulative costs incurred to date)/(estimate of total costs over contract)
Cumulative revenue recognized = % completed x estimated total collections from contract
- Cumulative revenue recognized not dependent on actual cash collections/billings through
end of period; total expected collections over life of contract determine cumulative
revenue recognized
Current period rev = cumulative rev to be recognized rev recognized in prior periods
Current period gross profit = current period rev current period costs
Gross profit earned to date = [(costs incurred to date)/(estimated total costs) x estimated
total profit] profit recognized in previous years = profit to be recognized in current year
When firm incurs costs of construction as construction occurs:
DB Construction in process
xxx
CR
Raw materials, cash, wages payable, accum. depr. etc. xxx
where xxx represents current period costs; construction in process = type of inventory
account
At end of period, record gross profit for period
DB Construction in process
PLUG
DB Construction expenses
zzz
CR
Construction revenue
yyy
where yyy = current period rev described earlier and zzz = current period costs
- Construction revenue and construction expenses appear on income statement
Entry to record billings to customers:
DB Accounts receivable
$$$
CR
Billings on construction in process
$$$
Over life of contract, total credits to Billings on Construction in process will = total
amount billed to customer; represents total revenue received over life of contract
Billings on construction in process can be thought of contra-account to construction in
process; at end of any period, difference between balance in construction in process and
billings on construction in process will appear on balance sheet
- If construction in process > billings on construction in process, difference will appear on
balance sheet as asset; if vice versa, appear as liability
Record collections from customer:
DB Cash $$$
CR
A/R
$$$
Cash collections from customer do no affect Net Income
Completion of contract:
DB Billings on construction in process
xxx
SEC criteria for revenue recognition:
1) Persuasive evidence of arrangement
2) Delivery ahs occurred/services rendered
3) Sellers price to buyer is fixed/determinable
4) Collectiblity is reasonably assured
In Bill and Hold arrangement, seller may only recognize revenue prior to delivery if
buyer is party requesting arrangement
SFAS130 says that companies must report comprehensive income in the following ways
Separate statement
Addition to income statement
Addition to changes in owners equity
However, ASU 2011-05 eliminated the Owners Equity option