Unformatted text preview: Chapter 1 – Accounting Standards
Focus on the Following Objectives: 1. Elements of Financial Reporting and Demand for Financial Reports 2. Why do we need accounting standards (high quality)? 3. What is the process by which standards are developed? 4. GAAP – what does it mean; how defined? Codification 5. International Dimensions • EOC for Application
CA1-8, CA1-9 1 Preview - Financial Accounting and Accounting Standards Financial Statements and Financial Reporting
Accounting and capital allocation Challenges Objectives Need to develop standards Parties Involved in Standard Setting Generally Accepted Accounting Principles FASB Codification Issues in Financial Reporting Securities and Exchange Commission American Institute of CPAs Financial Accounting Standards Board Changing role of the AICPA Political environment Expectations gap International accounting standards Ethics 2 What is Accounting?
• You learned in AIS 100 that the essential characteristics of accounting are: (1) the identification, measurement, and communication of financial information about (2) economic entities to (3) interested parties. Financial accounting is about reporting to external parties (usually investors and creditors) 3 Financial Statements and Financial Reporting
Economic Entity Financial Information Accounting? Identifies and Measures and Communicates Financial Statements
Balance Sheet Income Statement Statement of Cash Flows Statement of Owners’ or Stockholders’ Equity Note Disclosures Additional Information
President’s letter Prospectuses, SEC Reporting News releases Forecasts Environmental Reports Etc. GAAP Not GAAP LO 1 Identify the major financial statements and other means of financial reporting.. 4 Accounting and Capital Allocation
Resources are limited. Efficient use of resources often determines whether a business thrives.
Illustration 1-1 Capital Allocation Process Financial Reporting
Information to help users with capital allocation decisions. Users
Investors, creditors, and other users Capital Allocation
The process of determining how and at what cost money is allocated among competing interests. 5 LO 2 Explain how accounting assists in the efficient use of scare resources. Demand for Financial Reporting
(Accounting Reports) Quality High / Low Capital Demanders •Accounting Standards • Auditors •Regulators (rules and enforcement) •Analysts Investors and Creditors C of C Low / High Loans & Investments @ Cost of Capital
6 Objectives of Financial Accounting
Financial reporting should provide information that:
(a) is useful to present and potential investors and creditors and other users in making rational investment, credit, and similar decisions. (b) helps present and potential investors and creditors and other users in assessing the amounts, timing, and uncertainty of prospective cash receipts. (c) clearly portrays the economic resources of an enterprise, the claims to those resources, and the effects of transactions, events, and circumstances that change its resources and claims to those resources. A good way to think about this (and how the usefulness of accounting reports has been studied, is in the following prediction framework). 7 LO 4 List the objectives of financial reporting. Accounting Reports -- Useful in Prediction
Life of Firm Future Today Revenue - Expense --------------NI Accounting Measurement Price = PV (FCF)
8 Need to Develop Standards
Various users need financial information Financial Statements Balance Sheet Income Statement Statement of Stockholders’ Equity Statement of Cash Flows Note Disclosure The accounting profession has attempted to develop a set of standards that are generally accepted and universally practiced. Generally Accepted Accounting Principles (GAAP) 9 LO 5 Explain the need for accounting standards. Parties Involved in Standard Setting Three organizations: Securities and Exchange Commission (SEC) Financial Accounting Standards Board (FASB) American Institute of Certified Public Accountants (AICPA) … very minor role today. LO 6 Identify the major policy - setting bodies and 10 their role in the standard- setting process. Securities and Exchange Commission
Established by federal government in response to 1929 market crash. Accounting and reporting for public companies – Securities Acts of 1933 & 1934. Encouraged private standard-setting body – has endorsed the FASB – with SEC Oversight SEC requires public companies to adhere to GAAP – it has enforcement authority (unique internationally). LO 6 Identify the major policy - setting bodies and 11 their role in the standard- setting process. Financial Accounting Standards Board
Wheat Committee’s recommendations resulted in the creation of a the Financial Accounting Standards Board in 1973. Financial Accounting Foundation Financial Accounting Standards Board
Financial Accounting Standards Advisory Council Selects members of the FASB Funds their activities Exercises general oversight. Mission to establish and improve standards of financial accounting and reporting. Consult on major policy issues. LO 6 Identify the major policy - setting bodies and 12 their role in the standard- setting process. Financial Accounting Standards Board
Mission is to establish and improve standards of financial accounting and reporting. Differences between FASB and APB include: Full-time, Remunerated Membership Greater Autonomy / Independence – oversight by SEC Broader Representation (CPAs, Users, Preparers) http://www.fasb.org/ LO 6 Identify the major policy - setting bodies and 13 their role in the standard- setting process. Due Process – How are Standards Developed
FASB relies on two basic premises:
(1) (2) Responsive to entire economic community Operate in full view of the public
• • Step 1 = Topic placed on agenda Step 2 = Research conducted and Discussion Memorandum issued. Step 3 = Public hearing Step 4 = Board evaluates research, public response and issues Exposure Draft Step 5 = Board evaluates responses and issues final Statement of Financial Accounting Standard
LO 6 Identify the major policy - setting bodies and 14 their role in the standard- setting process. • • • Types of Pronouncements
Issued by the FASB:
• Standards, Interpretations, and Staff Positions – now issued as standards updates to the Codification (see below). Financial Accounting Concepts Emerging Issues Task Force Statements. • • LO 6 Identify the major policy - setting bodies and 15 their role in the standard- setting process. Changing Role of AICPA
The AICPA established the Accounting Standards Executive Committee (AcSEC): Audit and Accounting Guides Statements of Position (SOP) Practice Bulletins AICPA and AcSEC no longer issues authoritative accounting guidance for public companies. PCAOB oversees the development of auditing standards. AICPA continues to develop and grade the CPA examination. LO 6 Identify the major policy - setting bodies 6 LO and 16 their role in the standard- setting process. Generally Accepted Accounting Principles Those principles that have substantial authoritative support.
• FASB Standards, Interpretations, and Staff Positions • APB Opinions • AICPA Accounting Research Bulletins Major sources of support are: •GAAP (all authoritative elements) is now defined as whether guidance is included in the Codification.
•When the FASB develops new accounting guidance, it becomes authoritative when the FASB includes it in the Codification in a “Standards Update”.
LO 7 Explain the meaning of generally accepted accounting principles 17 (GAAP) and the role of the Codification for GAAP. Codification = GAAP
Illustration 1-4 GAAP Documents LO 7 Explain the meaning of generally accepted accounting principles (GAAP) and the role of the Codification for GAAP. 18 Issues in Financial Reporting
Standard Setting in a Political Environment
Accounting standards are as much a product of political action as they are of careful logic or empirical findings. The FASB due process, by inviting input from constituencies opens it up to political influences… referred to as Economic Consequences 19 LO 8 Describe the impact of user groups on the rule- making process. Standard Setting
Business Entities CPAs and Accounting Firms Illustration 1-6 User Groups that Influence Accounting Standards Financial Community Preparers
(e.g., FEI) AICPA (AcSEC) FASB Academicians Government
(SEC, IRS, other agencies) Investing Public Industry Associations Accounting standards, interpretations, and bulletins
20 LO 8 Describe the impact of user groups on the rule- making process. Concepts for Analysis 1-8
Presented below are three models for setting GAAP. (1) The purely political approach, (2) the private/professional approach and (3) a mixed approach of public and private. (a) Which of these three models best describes standard-setting in the United States? Comment on your answer. (b) Why do companies, financial analysts, labor unions, industry trade associations, and others take such an active interest in standard-setting? (c) Cite an example of a group other than the FASB that attempts to establish accounting standards. Speculate as to why another group might wish to set its own standards.
21 Issues in Financial Reporting
Ethics in the Environment of Financial Accounting As we discussed last time, implementing GAAP many times requires judgments…
As a result, we frequently encounter ethical dilemmas.
• • GAAP does not always provide an answer Doing the right thing is not always easy or obvious Judgment framework…. LO 9 Understand issues related to ethics and financial accounting. Accounting Judgments Adherence to Standards SEC – Enforces standards for public companies -Ultimate responsibility AICPA – Code of ethics and professional responsibilities PCAOB – Result of Sarbanes Oxley – oversees preparers and auditors. Ultimate bottom line • Good Accounting provided by good (ethical ) accountants is key to ensuring credible, high quality reporting. • This is our product and why accounting professionals are valued in the marketplace… WE SERVE THE PUBLIC!
24 International Accounting Standards
Two sets of standards accepted for international use:
• • U.S. GAAP, issued by the FASB International Financial Reporting Standards (IFRS), issued by the IASB FASB and IASB recognize that global markets will best be served if only one set of GAAP is used. 25 LO 8 Describe the impact of user groups on the rule- making process. International Accounting
Standards must be high quality…
1. Permit few alternative practices. 2. Be clearly stated, to allow for easy interpretation and consistent application. 3. Be comprehensive, covering the major transactions facing companies, and must provide an effective system for responding to new transactions. 4. Provide transparency of information to make that information relevant for making effective decisions. 26 International Accounting
Who are the key players? IASB – International Accounting Standards Board develops the standards, which are referred to as International Financial Reporting Standards (IFRS). Other Organizations National Standard-Setters IOSCO – International Organization of Securities Commissions 27 International Accounting
IASB – structure very similar to FASB, as is Due Process 28 Status Report – Timeline
• Recent events suggest we are on a fast-track to international convergence.
– Over 100 countries have adopted some form of IFRS and all traded companies in the EU (since 2005) must use IFRS. – SEC FPI Reconciliation went away after March 2008 (currently affects ~ 140 SEC registrants) • Thus, some believe that use of IFRS in the U.S. (a big capital market) is just around the corner. • SEC Position (February, 2010 Statement):
– Affirms support for a single set of high quality standards – and that IFRS appears to be the best option to achieve this. – Affirms previously established 2011 as the date for the SEC to decide on mandated IFRS use. If “switch is flipped”:
• Public companies could begin using IFRS in 2015. • SEC Staff is conducting studies to help Commission make decision – need to be sure we are ready.
29 Convergence Timeline 30 Summary -- Convergence Timeline
Accounting Plane IFRS Converged High Quality Standards U.S. GAAP Today
•Auditing, Interpretation, Enforcement •Standard-setting Structure & Governance •Investor / Regulatory readiness. Build out & Improve ~2015 -16 “Infrastructure” Plane 31 Issues in Financial Reporting
CA1-9 (GAAP Terminology): With accounting and finance, it often helps to be fluent in abbreviations and acronyms. Instructions: Presented below is a list of common accounting acronyms. Identify the term for which each acronym stands, and provide a brief definition of each term. (a) AICPA (b) CAP (c) ARB (d) APB (e) FAF (f) FASAC (g) SOP (h) GAAP (i) CPA (j) FASB (k) SEC (l) IASB 32 LO 9 Understand issues related to ethics and financial accounting. ...
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- Spring '08
- Financial Accounting, International Financial Reporting Standards, Financial Accounting Standards Board