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Unformatted text preview: CHAPTER 1
Financial Accounting and Accounting Standards
ASSIGNMENT CLASSIFICATION TABLE
Topics Questions 1. Subject matter of accounting. 1 2. Environment of accounting. 2, 3, 4 3. Role of principles, objectives, standards,
and accounting theory. 5, 6, 7 4. Historical development of accounting standards. 8, 9, 10, 11 5. Authoritative pronouncements
and standards-setting bodies. 12, 13, 14, 15, 16, 17, 18, 19,
20, 21, 22, 23 6. Role of pressure groups. 23, 24, 25, 26, 27, 28 7. International accounting. 29, 30 8. Ethical issues. 31 © 2008 For Instructor Use Only 1-1 ANSWERS TO QUESTIONS
1. Financial accounting measures, classifies, and summarizes in report form those activities and that
information which relate to the enterprise as a whole for use by parties both internal and external to a
business enterprise. Managerial accounting also measures, classifies, and summarizes in report
form enterprise activities, but the communication is for the use of internal, managerial parties, and
relates more to subsystems of the entity. Managerial accounting is management decision oriented
and directed more toward product line, division, and profit center reporting.
2. Financial statements generally refer to the four basic financial statements: balance sheet, income
statement, statement of cash flows, and statement of changes in owners’ or stockholders’ equity.
Financial reporting is a broader concept; it includes the basic financial statements and any other
means of communicating financial and economic data to interested external parties. Examples of
financial reporting other than financial reports are annual reports, prospectuses, reports filed with the
government, news releases, management forecasts or plans, and descriptions of an enterprise’s
social or environmental impact.
3. If a company’s financial performance is measured accurately, fairly, and on a timely basis, the right
managers and companies are able to attract investment capital. To provide unreliable and irrelevant
information leads to poor capital allocation which adversely affects the securities market.
4. Some major challenges facing the accounting profession relate to the following items:
Non-financial measurement—how to report significant key performance measurements such as
customer satisfaction indexes, backlog information and reject rates on goods purchased.
Forward-looking information—how to report more future oriented information.
Soft assets—how to report on intangible assets, such as market know-how, market dominance,
and well-trained employees.
Timeliness—how to report more real-time information.
5. In general, the objectives of financial reporting are to provide (1) information that is useful in
investment and credit decisions, (2) information that is useful in assessing cash flow prospects,
and (3) information about enterprise resources, claims to those resources, and changes in them.
More specifically these objectives state that financial reporting should provide information:
a. that is useful to present and potential investors and creditors and other users in making rational
investment, credit, and similar decisions. The information should be comprehensible to those
who have a reasonable understanding of business and economic activities and are willing to
study the information with reasonable diligence.
b. to help present and potential investors and creditors and other users in assessing the amounts,
timing, and uncertainty of prospective cash receipts from dividends or interest and the proceeds
from the sale, redemption, or maturity of securities or loans. Since investors and creditors’ cash
flows are related to enterprise cash flows, financial reporting should provide information to help
investors, creditors, and other users assess the amounts, timing, and uncertainty of prospective
net cash inflows to the related enterprise.
c. about the economic resources of an enterprise, the claims to those resources (obligations of the
enterprise to transfer resources to other entities), owners’ equity, and the effects of transactions,
events, and circumstances that change its resources and claims to those resources.
6. A common set of standards applied by all businesses and entities provides financial statements
which are reasonably comparable. Without a common set of standards, each enterprise could, and
would, develop its own theory structure and set of practices, resulting in noncomparability among
enterprises. © 2008 For Instructor Use Only 1-2 Questions Chapter 1 (Continued)
7. General-purpose financial statements are not likely to satisfy the specific needs of all interested
parties. Since the needs of interested parties such as creditors, managers, owners, governmental
agencies, and financial analysts vary considerably, it is unlikely that one set of financial statements
is equally appropriate for these varied uses.
8. The SEC has the power to prescribe, in whatever detail it desires, the accounting practices and
principles to be employed by the companies that fall within its jurisdiction. Because the SEC receives
audited financial statements from nearly all companies that issue securities to the public or are listed
on the stock exchanges, it is greatly interested in the content, accuracy, and credibility of the
statements. For many years the SEC relied on the AICPA to regulate the profession and develop
and enforce accounting principles. Lately, the SEC has assumed a more active role in the development of accounting standards, especially in the area of disclosure requirements. In December 1973,
in ASR No. 150 (affirmed following passage of the Sarbanes-Oxley Act in 2002) the SEC said the
FASB’s statements would be presumed to carry substantial authoritative support and anything
contrary to them to lack such support. It thereby supports the development of accounting principles
in the private sector.
9. The Committee on Accounting Procedure was a special committee of the American Institute of CPAs
that, between the years of 1939 and 1959, issued 51 Accounting Research Bulletins dealing with
a wide variety of timely accounting problems. These bulletins provided solutions to immediate
problems and narrowed the range of alternative practices. But, the Committee’s problem-by-problem
approach failed to provide a well-defined and well-structured body of accounting theory that was so
badly needed. The Committee on Accounting Procedure was replaced in 1959 by the Accounting
10. The creation of the Accounting Principles Board was intended to advance the written expression
of accounting principles, to determine appropriate practices, and to narrow the differences and
inconsistencies in practice. To achieve its basic objectives, its mission was to develop an overall
conceptual framework to assist in the resolution of problems as they became evident and to do
substantive research on individual issues before pronouncements were issued.
11. Accounting Research Bulletins were pronouncements on accounting practice issued by the
Committee on Accounting Procedure between 1939 and 1959; since 1964 they have been
recognized as accepted accounting practice unless superseded in part or in whole by an opinion of
the APB or an FASB standard. APB Opinions were issued by the Accounting Principles Board
during the years 1959 through 1973 and, unless superseded by FASB Statements, are recognized
as accepted practice and constitute the requirements to be followed by all business enterprises.
FASB Statements are pronouncements of the Financial Accounting Standards Board and
currently represent the accounting profession’s authoritative pronouncements on financial accounting
and reporting practices.
12. The explanation should note that generally accepted accounting principles or standards have
“substantial authoritative support.” They consist of accounting practices, procedures, theories,
concepts, and methods which are recognized by a large majority of practicing accountants as well
as other members of the business and financial community. Bulletins issued by the Committee on
Accounting Procedure, opinions rendered by the Accounting Principles Board, and statements
issued by the Financial Accounting Standards Board constitute “substantial authoritative support.”
13. It was believed that FASB Statements would carry greater weight than APB Opinions because of
significant differences between the FASB and the APB, namely: (1) The FASB has a smaller
membership of full-time compensated members; (2) the FASB has greater autonomy and increased
independence; and (3) the FASB has broader representation than the APB. © 2008 For Instructor Use Only 1-3 Questions Chapter 1 (Continued)
14. The technical staff of the FASB conducts research on an identified accounting topic and prepares
a “discussion memorandum” that is released by the Board for public reaction. The Board analyzes
and evaluates the public response to the discussion memorandum, deliberates on the issues, and
issues an “exposure draft” for public comment. The discussion memorandum merely presents all
facts and alternatives related to a specific topic or problem, whereas the exposure draft is a
tentative “statement.” After studying the public’s reaction to the exposure draft, the Board may
reevaluate its position, revise the draft, and vote on the issuance of a final statement.
15. Statements of financial accounting standards constitute generally accepted accounting principles
and dictate acceptable financial accounting and reporting practices as promulgated by the FASB.
The first standards statement was issued by the FASB in 1973.
Statements of financial accounting concepts do not establish generally accepted accounting
principles. Rather, the concepts statements set forth fundamental objectives and concepts that the
FASB intends to use as a basis for developing future standards. The concepts serve as guidelines
in solving existing and emerging accounting problems in a consistent, sound manner. Both the
standards statements and the concepts statements may develop through the same process from
discussion memorandum, to exposure draft, to a final approved statement.
16. Rule 203 of the Code of Professional Conduct prohibits a member of the AICPA from expressing
an opinion that financial statements conform with GAAP if those statements contain a material
departure from an accounting principle promulgated by the FASB, or its predecessors, the APB
and the CAP, unless the member can demonstrate that because of unusual circumstances the
financial statements would otherwise have been misleading. Failure to follow Rule 203 can lead to
a loss of a CPA’s license to practice. This rule is extremely important because it requires auditors
to follow FASB standards.
17. FASB Standards, FASB Technical Bulletins, AICPA Practice Bulletins.
18. The chairman of the FASB was indicating that too much attention is put on the bottom line and not
enough on the development of quality products. Managers should be less concerned with shortterm results and be more concerned with the long-term results. In addition, short-term tax benefits
often lead to long-term problems.
The second part of his comment relates to accountants being overly concerned with following a set
of rules, so that if litigation ensues, they will be able to argue that they followed the rules exactly.
The problem with this approach is that accountants want more and more rules with less reliance
on professional judgment. Less professional judgment leads to inappropriate use of accounting
procedures in difficult situations.
In the accountants’ defense, recent legal decisions have imposed vast new liability on accountants.
The concept of accountant’s liability that has emerged in these cases is broad and expansive; the
number of classes of people to whom the accountant is held responsible are almost limitless.
19. FASB Staff Positions (FSP) are used to provide interpretive guidance and to make minor amendments to existing standards. The due process used to issue a FSP is the same used to issue a
new standard. © 2008 For Instructor Use Only 1-4 Questions Chapter 1 (Continued)
20. The Emerging Issues Task Force often arrives at consensus conclusions on certain financial
reporting issues. These consensus conclusions are then looked upon as GAAP by practitioners
because the SEC has indicated that it will view consensus solutions as preferred accounting and
will require persuasive justification for departing from them. Thus, at least for public companies
which are subject to SEC oversight, consensus solutions developed by the Emerging Issues Task
Force are followed unless subsequently overturned by the FASB. It should be noted that the FASB
took greater direct ownership of GAAP established by the EITF by requiring that consensus
positions be ratified by the FASB.
21. The Governmental Accounting Standards Board, under the oversight of the Financial Accounting
Foundation, was created in 1984 to address state and local governmental reporting issues. The
new board has replaced a number of organizations that set rules for government accounting. The
National Council on Governmental Accounting, a voluntary body affiliated with the Municipal
Finance Officers Association, was the primary standard setter for about 100,000 government units.
But many other organizations also offered guidance for government accounting. The GASB will
consolidate the rules into one body.
22. Possible reasons might be:
1. The objectives of financial reporting for other types of enterprises (government, railroads, etc.)
are not sufficiently different from those established by the FASB to warrant a separate
2. The existence of competing standard-setting bodies would create serious jurisdictional conflicts.
3. The framework is already in place within the existing structure to enforce the standards
promulgated by the FASB.
4. The FASB already has significant support from user groups of external financial reports. Uncertainty exists concerning the ability of any other standard-setting body to gain such support.
23. The sources of pressure are innumerable, but the most intense and continuous pressure to
change or influence accounting principles or standards come from individual companies, industry
associations, governmental agencies, practicing accountants, academicians, professional accounting organizations, and public opinion.
24. Economic consequences means the impact of accounting reports on the wealth positions of
issuers and users of financial information and the decision-making behavior resulting from that
impact. In other words, accounting information impacts various users in many different ways which
leads to wealth transfers among these various groups.
If politics plays an important role in the development of accounting standards, standards will be
subject to manipulation for the purpose of furthering whatever policy prevails at the moment. No
matter how well intentioned the standards setter may be, if information is designed to indicate that
investing in a particular enterprise involves less risk than it actually does, or is designed to
encourage investment in a particular segment of the economy, financial reporting will suffer an
irreplaceable loss of credibility.
25. No one particular proposal is expected in answer to this question. The students’ proposals,
however, should be defensible relative to the following criteria:
1. The method must be efficient, responsive, and expeditious.
2. The method must be free of bias and be above or insulated from pressure groups.
3. The method must command widespread support if it does not have legislative authority.
4. The method must produce sound yet practical accounting principles or standards.
The students’ proposals might take the form of alterations of the existing methodology, an accounting
court (as once proposed by Leonard Spacek), or governmental device. © 2008 For Instructor Use Only 1-5 Questions Chapter 1 (Continued)
26. Concern exists about fraudulent financial reporting because it can undermine the entire financial
reporting process. Failure to provide information to users that is accurate can lead to inappropriate
allocations of resources in our economy. In addition, failure to detect massive fraud can lead to
additional governmental oversight of the accounting profession.
27. The expectations gap is the difference between what people think accountants should be doing
and what accountants think they can do. It is a difficult gap to close. The accounting profession
recognizes it must play an important role in narrowing this gap. To meet the needs of society, the
profession is continuing its efforts in developing accounting standards, such as numerous
pronouncements issued by the FASB, to serve as guidelines for recording and processing
business transactions in the changing economic environment.
28. The following are some of the key provisions of the Sarbanes-Oxley Act:
• Establishes an oversight board for accounting practices. The Public Company Accounting Oversight Board (PCAOB) has oversight and enforcement authority and establishes auditing, quality
control, and independence standards and rules.
• Implements stronger independence rules for auditors. Audit partners, for example, are required
to rotate every five years and auditors are prohibited from offering certain types of consulting
services to corporate clients.
• Requires CEOs and CFOs to personally certify that financial statements and disclosures are
accurate and complete and requires CEOs and CFOs to forfeit bonuses and profits when there
is an accounting restatement.
• Requires audit committees to be comprised of independent members and members with financial expertise.
• Requires codes of ethics for senior financial officers.
In addition, Section 404 of the Sarbanes-Oxley Act requires public companies to attest to the
effectiveness of their internal controls over financial reporting.
29. Some of the reasons for difference are:
1. The objectives of financial reporting are often different in foreign countries.
2. The institutional structures are often not comparable.
3. Strong national tendencies are pervasive and therefore there is reluctance to adopt any one
30. Relevant and reliable financial information is a necessity for viable capital markets. Unfortunately,
financial statements from companies outside the United States are often prepared using different
financial statements than U.S. GAAP. As a result, international companies have to develop financial
information in different ways. Beyond the additional costs these companies incur, users of financial
statements are often forced to understand at least two sets of GAAP. It is not surprising that there
is a growing demand for one set of high quality international standards.
31. Accountants must perceive the moral dimensions of some situations because GAAP does not
define or cover all specific features that are to be reported in financial statements. In these instances
accountants must choose among alternatives. These accounting choices influence whether
particular stakeholders may be harmed or benefited. Moral decision-making involves awareness of
potential harm or benefit and taking responsibility for the choices. © 2008 For Instructor Use Only 1-6 AIA 1-1 FINANCIAL STATEMENT ANALYSIS
(a) The key organizations involved in standard setting in the U.S. are the
AICPA, FASB, and SEC. See also (c).
(b) Different authoritative literature pertaining to methods recording accounting transactions exists today. Some authoritative literature has received
more support from the profession than other literature. The literature that
has substantial authoritative support is the one most supported by the
profession and should be followed when recording accounting transactions. These standards and procedures are called generally accepted
accounting principles (GAAP). There are four different levels, and the firs...
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- Accounting, Financial Accounting Standards Board