Chapter 9

Intangible assets are often particularly hard to measure. Some intangibles, such as goodwill, will only appear on the balance sheet if they have been purchased, rather than developed by the organization.  Also, assets often appear on the balance sheet based on their acquisition cost to the organization, rather than based on their current market value.

The CPA’s audit examines the financial statements and the underlying financial records of an organization. Based on their examination, they issue a letter that gives their opinion as to whether the financial statements are free of material (substantial) misstatements and whether they conform to Generally Accepted Accounting Principles (GAAP). GAAP help create some degree of uniformity.

In order to avoid confusion, we want to specifically identify the entity that is the focus of a set of financial reports. Each entity views the world from its own perspective. One transaction could give rise to an asset on the financial records of one entity and a mirror-image liability on the records of another entity.

All events that have a financial element must have a monetary figure attached to them. The reason this convention exists is related to the need for communication. Suppose that you were trying to tell someone what assets the organization has...chairs, tables, desks... The benefit of the monetary denominator is that it allows us to summarize information into a more useful form.

In order to avoid subjectivity, we often wind up recording assets based on their cost, rather than their current value. This results in values on the balance sheet that can be quite misleading.

Equity securities are now reported on the balance sheet based on their fair market value, rather than on the lower of cost or market.

If there is a significant question regarding an organization’s ability to continue operations, the valuation of all of its assets must be reconsidered, based on liquidation values. Users of the financial statements must be informed of the significant uncertainties that exist.

CPAs try to find and eliminate all material errors. However, it is virtually impossible to find every error. Material errors are those that might affect a decision made by a user of the financial report.

GAAP require organizations to report their financial position and results of operations on an accrual basis. This means that revenues are recorded in the year that the organization provides goods or services and becomes legally entitled to payment. Expenses are recorded in the year that assets have been consumed in the process of providing goods and services.

records revenue when cash is received and expense when cash is paid. The rationale for using accrual accounting is that it provides a better measure of how well the organization has done for the year. The cash basis can be quite misleading because there may be a poor matching of revenue and expense in any one year. This can lead to substantially over or understated measures of income.

The primary requirement for classification as a current asset is management’s expectation or intention to convert the asset to cash or use it up within a year. Thus, an investment in Microsoft stock would be a current asset only if we expect to sell it in the coming year. Otherwise the stock would be treated as a long-term asset.

Assets are shown on the balance sheet in the order of liquidity, with the most liquid assets listed first. Liquidity refers to how close an asset is to being cash. The more quickly an asset can become cash available for spending, the more liquid the asset is. Liquid assets are readily available to pay the organization’s obligations. Cash, and cash equivalents, are always considered to be the most liquid assets, assuming that they are available for use.

The current rules for not-for-profit organizations require them to report all equity and nonequity securities that have readily determinable fair values at their fair value on the balance sheet. If a for-profit organization expects to hold a bond until it matures, it reports it on the balance sheet at its amortized cost.

The Titanic is a boat that sank. Sinking funds have nothing to do with sinking. They are asset investment accounts that are earmarked for a specific purpose, such as repaying a bond or replacing buildings and/or equipment.

The details of total cost and accumulated depreciation tell much more about the size of an organization and the age of its facilities than we can learn from the net value.

Assets are recognized when three conditions have all been met. They must (1) be owned by the entity, (2) have a monetary value, and (3) have a monetary value that is able to be objectively measured.

Liabilities are recognized when they are legally owed and will have to be paid and the amount to be paid can be objectively measured.

The central recording device used by accountants is the journal, generally referred to as the general journal. A journal is simply a chronological listing of every financial event that affects the organization. The journal is similar to a diary in that events are listed in the order they occur and as concurrently as possible. When an event occurs and is entered into the journal, the process is referred to as making a journal entry.

In order to describe an entire event, it is necessary to record a change to at least two elements in the fundamental equation. That does not mean, however, that there must be a change on each side of the equation. There can be off-setting changes in items on just one side. Nor does it mean that a transaction can affect just two accounts. Double-entry bookkeeping doesn’t limit the number of accounts that can change as part of one transaction

A debit represents an increase in an asset or expense. A credit represents an increase in a liability or revenue. A debit is an increase in anything on the left side of the transformed fundamental equation:

A credit is an increase in anything on the right side of this equation. Conversely, a credit is a decrease in anything on the left side of the equation. A debit is a decrease in anything on the right side of the equation.