| What I Have Learned in This Class |
|
We are poor estimators (90% confidence range experiment)
| |
* Provide wide enough ranges to account for our propensity to err when estimating |
| |
* Hold some measure of skepticism toward your and others' estimates |
We are biased by what we are exposed to more (The Availability Heuristic)
| |
* We overestimate the probability of things we hear and see often |
| |
* We underestimate the probability of things we do not hear and see often |
Escalation of Commitment ($20 Bill Auction)
| |
* We know about sunk costs, but do we always apply that knowledge in business? |
| |
* When do we know to stop? |
Confirmation Bias and Divergent Opinions (Fuzzy Math - Jeweler and NSF Check)
| |
* We tend to look for confirmation of our opinions, ideas, calculations, etc., not for disconfirming |
| |
* We should seek input from those who see differently from us and be willing to change our conclusion |
Concentration and Peripheral Vision (Gorilla Video)
| |
* We tend to focus on a stated objective or assignment and not use our peripheral vision [actually (sight) and metaphorically (thinking) during the process. This can often lead to a neglect in observing our environment and we may miss that our old thought paradigm no longer applies. |
| |
* Take a breather and look around every once in awhile. What 'Gorillas' are you missing? |
Really Good or Just Probability Carried Out (The Best Trader in the World Experiment)
| |
* We find instances of people who can walk on water. Are they really that good or are they the 1 in 300,000,000 that probability would explain the occurrence to rise from luck? |
| |
* What is the underlying activity? Does it make sense that they could be really that good at it? Many in the class where skeptical . . . a good characteristic |
Identifying Patterns (2, 4, 6, Pattern Experiment)
| |
* We tend to conclude a pattern in our mind prematurely. We test possibilities which follow our pattern, but do not account that it may just be a subset of the actual pattern (e.g. Add the last two positive digits to make the next positive digit will always be a subset of the pattern 'numbers in increasing order) |
| |
* Consider that a pattern you have discovered may be wrong or only a subset of the true pattern. Look for evidence outside of your detected pattern. Only one person offered a pattern (3, 2, 1) to which I said no and they immediately answered correctly. |
Sometimes There is No Pattern (Random Number Sequence Experiment)
| |
* Our mind tends to look for patterns - it is a method by which we learn, remember and view the world. It is impossible to view any raw data, material, event, object, etc without some form of mental interpretation. Our tendency to discover patters, even when they don't exist, is a strong bias.
*** Another example of this mental interpretation is the Read Me Experiment. We skipped right over the two "the"s. The mind is exceptional at interpreting the data to make sense of what we observe, however, we are obviously missing some observations during this pursuit.
*** A fnail elpmaxe of tihs alibtiy taht the mnid has oevr us is the vrey fcat taht you can raed tihs steecne. |
| |
* We want (some of us REALLY want) to believe there is a pattern, want to see that next number, but alas, it is nothing more than radomness. Sometimes you have to admit that there is not a pattern. |
Our Understanding of Probability - (Lottery, Just Keep Betting Discussion)
| |
* We tend to not fully understand probability - use it incorrectly, apply emotions to it, misstate it, calculate it incorrectly |
| |
* 1, 2, 3, 4, 5, 6 has the same lottery odds of 12, 23, 38, 42, 45, 49. We only view 1, 2, 3, 4, 5, 6 because it doesn't make sense how the sequential order could possibly have the same probability. However, isn't this just another example of the Availability Heuristic? We see non-sequential lottery results a lot more on the news than sequential, so we overestimate the odds of one non-sequential ticket over a sequential ticket, even though both have the same odds.
* Playing the same lottery numbers every time have the same probability as playing different every time. This is hard to accept and I would love to disprove it, but the lottery balls do not have a memory of the numbers they have called in the past and, therefore, your number, whatever it is, has the same odds of winning this round as it did in every previous round. That being said and since both have the same odds, I would recommend playing the same numbers each time if for no other than a mental reason. The lottery is random, but you will only beat yourself up if those lucky numbers do actually show up. In hindsight, you will hate yourself for not seeing something so obvious, even though it is completely random and unpredictable. |
The Narrative Fallacy
| |
* We tend to overestimate the odds of an event for which we have a story or can visualize. |
| |
* Narratives are a valuable way to communicate to an audience, because the information is more organized, less random, patterned, and has context - which are all valuable to the way we remember things. |
Sometimes Rare Events Are Not So Rare (That's My Birthday Too! Experiment)
| |
* You need 367 people to be 100% confident that at least two people share a birthday |
| |
* You need only 23 people to be 50% confident that at least two people share a birthday |
|
|
Environment and Theoretical Structure of Financial Accounting
|
The audiences for Managerial/Cost Accounting and Financial Accounting
The four financial statements.
How investors get paid (capital gains/dividends)
What dividends can signal for the future of a company to investors
The Cash Flow Perspective of Accounting (Amount, Timing, Uncertainty)
Cash Basis of Accounting (Recognizing Revenues and Expenditures)
Accrual Basis of Accounting (Recognizing Revenues and Expenditures)
The reasons why a private business owner may prefer either cash or accrual accounting.
Understanding the justification of Accrual Accounting to achieve the goal of the Cash Flow Perspective
A background of the Financial Accounting and Reporting Standards Background
Committee on Accounting Procedures (CAP)
Accounting Principles Board (APB)
Financial Accounting Standards Board (FASB)
FASB Standard Setting involves issuing a memorandum, receiving public response, creating a exposure draft, more public response, and issuing a statement.
International Accounting Standards Board (IASB) is trying to address the difference in accounting standards between countries.
The Auditor is an independent intermediary to help insure that management has complied with Generally Accepted Accounting Principles (GAAP)
Key Aspects of Sarbanes-Oxley Act:
1.) Oversight Board
2.) Corporate executive accountability
3.) Non-audit services.
4.) Retention of work papers
5.) Auditor rotation
6.) Conflict of interest
7.) Hiring of auditor
8.) Internal control assessment and effectiveness.
Two main ideas about the general structure of accountancy: Principle-Based and Rule-Based
Principle-Based argues for a general framework and relying upon professional judgment
Rule-Based believes generalities will only lead to abuse and that we should have rules to follow
The accounting profession is leaning more toward Principle-Based (aka Objective-Oriented)
Statements of Financial Account Concepts (SFAC)
SFAC 1) The primary objective of financial reporting is to provide the user with useful information for decision making.
- The focus is on decision making
- Information to be comprehensible to someone who has a reasonable business and economic understanding
- User should be willing to study information with reasonable diligence
- Information should help others (investors and creditors) assess the amount, timing, and uncertainty of prospective cash flow
- Should provide information about the economic resources and obligations (the source of direct/indirect future cash inflows and outflows
SFAC 2)
- The focus is on Understandability
- Two Primary Decision Qualities:
1) Relevance
- Information must possess predictive or feedback value (e.g. earnings' quality)
- Timeliness - available early enough to be used in the decision process
2) Reliability
- Verifiability - Objectivity (e.g. the historical cost of a house is objective, its current value would most likely be a little more subjective)
- Representational Faithfulness - The measurement and description matches the underlying object(s) being measured or described.
- Neutrality - Information is neutral to potentially affected parties (i.e. not skewed, biased, etc.)
* Potential clash - Relevance versus Reliability (e.g. timely vs verifiable and net income forecasts (predictive value, not verifiable))
- Two Secondary Characteristics:
1) Comparability - Helps users to see similarities and differences between events and conditions (able to compare companies/competitors)
2) Consistency - The ability to compare financial reporting for the same company over different periods because similar methods are used consistently. Remember, accounting change requires a disclosure note.
Accounting Constraints:
- Cost Effectiveness (Cost/Benefit Analysis) - Do the potential benefits outweigh the costs?
- Materiality - Does it have a material effect on the decision? (Mercedes / Pita example)
- Conservatism
* Practical justification for some accounting decisions - Err on the side of conservatism
* Not a 'Desirable Characteristic'
* Not an 'Accounting Principle'
SFAC 6) Defines the 10 elements of financial statements
1) Assets - Probable future economic benefit obtained or controlled by the company
2) Liabilities - Probable future sacrifices of economic benefit arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events.
3) Equity - The residual interest in the assets of an entity that remains after deducting the liabilities (Equity = A - L)
4) Investments by Owners - Increase in equity resulting from the transfer of an asset in consideration for ownership interest.
5) Distributions to Owners - Decrease in equity resulting from transfers to owners (dividends)
6) Revenues - Inflows or other enhancements of assets or settlements of liabilities from delivering or producing goods, rendering services, or other activities that constitute the entity's ongoing major, or central, operations.
7) Gains - Increases in equity from peripheral, or incidental, transactions of an entity
8) Expenditures - Outflows or other using up of assets or incurrence of liabilities during a period from delivering or producing goods, rendering services, or other activities that constitute the entity's ongoing major, or central, operations
9) Losses - Decreases in equity arising from peripheral, or incidental, transactions of an equity.
10) Comprehensive Income - The change in equity of a business enterprise during a period from transactions and other events and circumstances from nonowner sources. It includes all changes in equity during a period except those resulting from investments by owners and distributions to owners.
SFAC 5) Recognition - An item should be recognized in financial statements when it meets the following criteria:
1) Definition - The item meets the definition of an element of financial statements
2) Measurability - The item is measurable with sufficient reliability
3) Relevance - Capable of making a difference to the user's decisions
4) Reliability - The information is representationally faithful, verifiable, and neutral
SFAC 7) Measurement - Framework for using future cash flows in accounting measurements
- Nominal units of money without adjustments for changes in purchasing power (Mercedes example)
- Historical Cost
Underlying Accounting Assumptions:
- Economic Entity Assumption - All economic events can be identified with a particular economic entity
- Going Concern Assumption - Anticipates continued operations indefinitely (a Going Concern audit opinion is given when the auditor believes that the company is in serious jeopardy of not being a going concern).
- Periodicity Assumption - We can divide the economic life of a company into artificial periods (i.e. 3 quarterly financial statements and an annual statement ).
- Monetary Unit Assumption - We can describe financial reporting in US Dollars (e.g. $65,000 rather than "Mercedes")
Accounting Principles:
- Historical Cost Principle - Assets and liabilities should be based on the original transaction amount, rather than current value. This allows dollar amount for assets in the balance sheet to be more verifiable and objective.
- Realization Principle - When revenue can be recognized:
1) The earnings process is judged to be complete or virtually complete
2) There is reasonable certainty as to the collectibility of the asset to be received
* Revenue is recognized when earned, regardless of when cash is actually received
- Matching Principle - Expenditures are recognized in the same period as the related revenues.
- Full Disclosure - Financial statements should include any information that could affect the decisions made by external users
Ethics - By far, the most important aspect of accounting.
End of Chapter One. Good Luck on the Exam. Study well and know this information. Good Night.
|
|
Review of the Accounting Process
|
|
Economic Events - Directly affect the financial position of the company
- External Event - Involves an exchange between the company and a separate economic entity
- Internal Event - Affects the financial position, but does not involve an exchange with a different economic entity
Assets = Liability + Owner's Equity
- Assets are either owned by creditors (liabilities) or investors (Owner's Equity)
Double Entry Accounting System
- Each transaction has a dual effect on the accounting transaction (i.e. at least two accounts are affected for each economic transaction).
- Debits - Represent the left side (that's it)
- Credits - Represent the right side (that's it)
- Permanent Accounts (Assets, Liabilities, Shareholder's Equity - Accounts that you would find on the Balance Sheet).
- These accounts are not closed out each year.
- Temporary Accounts (Revenues, Expenses, Gains, Losses - Accounts which cause a change in Retained Earnings)
- These accounts are closed out each year when creating the income statement and then start with a zero balance in the following period.
Steps of the Accounting Process:
1) Obtain information about external transactions from source documents (e.g. Invoices, receipts, etc.)
2) Analyze the transaction.
- Review external transactions to determine the dual effect on the account equations (i.e. determine which accounts will be debited or credited to record the transaction).
3) Record the transaction in a journal
a) General Journal - A journal designed to be flexible enough to record any economic transaction. Column headings would primarily include:
* Date, Account Titles, Account Numbers, Supporting Explanation, Debit, and Credit
b) Special Journal - Used to record a repetitive type of transaction (Examples: Cash Receipt, Sales, and Purchases Journals)
* Simplify the recording process by:
I.) More efficient through specifically designed format
II.) Centralized accumulation of information concerning one category
III.) Allows delegating responsibility to a specialized group/person for that accounting category
4) Posting - Periodically posting of debit and credit information from the Journals to the General Ledger
- The General Ledger is a collection of the company's accounts
- The General Ledger accounts also contain a posting reference (which is normally the page number of the journal from which it was posted).
- A subsidiary ledger contains a group of subsidiary accounts associated with a particular general ledger control account (e.g. Accounts Receivable or Accounts Payable both have many groups of transactions - for example you would buy inventory multiple times from multiple suppliers and each would have an individual accounts payable account in your accounts payable subsidiary ledger)
5) Unadjusted Trial Balance - A list of the General Ledger accounts and their balances at a particular date
- Prepared before adjusting entries are recorded
- Shows both permanent and temporary accounts
- Purpose: To check completeness and to prove that credits and debits
- The fact the debits equal credits does not mean that they are correct - it could contain offsetting errors.
6) Adjusting Entries - Internal Events
- Recorded at the end of any period when financial statements are prepared
- Some accounts require updating because entries are necessary for the realization principle and matching principle
* Three kinds:
a) Prepayments - Cash flow precedes either expense or revenue
I.) Prepaid Expenses (Assets)
- Whenever cash is paid and it is not to 1) satisfy a liability or 2) pay a dividend or return capital to the owner, it must be determined whether or not the payment creates future benefit or if it is used in the current period.
- Example - prepaid rent
- Advertising should be expensed when used (AOL Disks Example)
II.) Unearned Revenue (Liability)
- When a company receives cash flow from a customer in one period for goods or services that are to be provided in a future period.
b) Accruals - Cash flow comes after either expenses or revenue recognition
I.) Accrued Liabilities - Concerned with expenses incurred but not yet paid (e.g. Accounts Payable)
II.) Accrued Receivables - Recognize revenue before cash is received (e.g. Accounts Receivable)
c) Estimates - Have to estimate in accounting many times (e.g. Bad Debt Expense and Warranty Liability)
7) Adjusted Trial Balance
- The adjusting entries have now been made, otherwise it is the same as step 5 (the Unadjusted Trial Balance)
- Shows both permanent and temporary account balances
8) Preparation of the Financial Statements
a) Income Statement
- Summarizes the profit generating business transactions occurring during a period of time
- Lists the temporary accounts in an organization that groups between operating and non-operating activities
- Shows the revenue, gains, expenses, and losses for the period
b) Balance Sheet
- Presents the financial position of the company at a moment in time (it is a snapshot as of a particular day)
- Classifies assets and liabilities between Current and Long-Term
* Current Assets (Liabilities) are assets (liabilities) which will be converted into (paid off by) cash within one year of a business cycle, whichever is longer.
* A Business Cycle for a manufacturer is Cash -> Raw Material -> Finished Product -> Accounts Receivable -> Cash
c) Statement of Cash Flow
- Shows change in cash for the period and is classified into three sections:
I) Operating Activities - Cash related to transactions related to determining Net Income
II) Investing Activities - Acquisition and Sale of long-term (e.g. buildings and equipment) or non-operating investments (e.g. stocks/bonds of other companies)
III) Financing Activities - Transactions with creditors and owners
- Prepared using either the Direct or Indirect Method
* Direct method states all cash inflows and outflows in their respective areas
* Indirect method starts with net income for the Operating Activities section and then works backwards by adding back any of the non-cash transactions and adding (subtracting) cash paid (received) for non-income generating activities such as paying off accounts payable or (receiving payment for accounts receivable).
* The Indirect method is required to be presented to investors
* The difference between the two methods is only seen in the Operating Activities (The Investing and Financing sections look the same).
d) Statement of Shareholder's Equity
- Shows the source of change in the various permanent shareholder's equity accounts
9) The Closing Process
- Temporary accounts are zeroed out, which prepares them for the next period.
- Temporary accounts are closed out into Retained Earnings, often through an intermediary account, such as Income Summary. Closing out each temporary account into this temporary Income Summary account, followed by the transferring of the net amounts to Retained Earnings makes for a clean and organized closing process.
10) Post- Closing Trial Balance
- Verify that the closing entries were prepared and posted correctly by seeing that only permanent accounts exist in the list and debits and credits are still equal
*** I would strongly recommend looking over your notes for Jamaal et al Hot Dogs and Illustration 2-3 on page 54. You will have a very large and important question on the test where you will have to enter journal entries and prepare T-Tables for these kind of transactions. ***
|
|