Financial Accounting and Reporting
The reporting framework
Financial accounting translates economic events into general-purpose statements under a chosen framework (US GAAP or IFRS). A candidate must know, at minimum: accrual accounting and adjusting entries (deferrals, accruals, estimates); the five-step revenue model (identify the contract, identify performance obligations, determine the transaction price, allocate it, recognize as obligations are satisfied); inventory costing and lower-of-cost-or-market; depreciation and impairment; lease classification; deferred taxes; stock compensation and EPS; consolidation with intercompany eliminations; and statement of cash flows presentation.
Traps that recur
- Cash flow classification. Under US GAAP, interest paid and interest/dividends received are operating; dividends paid are financing. Questions routinely swap these.
- Shipping terms. Revenue and risk transfer at the named point (shipping point vs. destination), not at the invoice date.
- Change in estimate vs. principle. Estimates are applied prospectively; a change in principle is generally retrospective.
- Gross vs. net. A principal reports gross revenue; an agent reports only its commission.
- Discontinued operations. Only a disposal representing a strategic shift qualifies, presented net of tax below income from continuing operations.
Worked example
A retailer ships goods costing $60 to a customer on December 28, FOB shipping point, for $100; the customer receives them January 3. Because control passed at shipment, the seller records $100 revenue and $60 cost of sales in the current year and carries a receivable - not inventory - at year end. Under FOB destination, no revenue would be recorded until January 3.
Rule of thumb: recognize revenue when control transfers, and classify cash flows by their economic nature rather than by where the related item sits on the income statement.