chapter 1&2

chapter 1&2 - Chapter 1 -- FINANCIAL ACCOUNTING Chapter 1...

Info iconThis preview shows page 1. Sign up to view the full content.

View Full Document Right Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: Chapter 1 -- FINANCIAL ACCOUNTING Chapter 1 FINANCIAL ACCOUNTING Chapter Chapter AND ACCOUNTING STANDARDS AND ACCOUNTING STANDARDS AND AND 1.. 1 Identify the major financial statements and other means of financial reporting. 2. Explain how accounting assists in the efficient use of scarce resources. 3. Describe some of the challenges facing accounting. 4. List the objectives of financial reporting. 5. Explain the need for accounting standards. 6. Identify the major policy­setting bodies and their role in the standard­setting process. 7. Explain the meaning of generally accepted accounting principles (GAAP) and the role of the Codification for GAAP. 8. Describe the impact of user groups on the rule­making process. 9. Understand issues related to ethics and financial accounting. Financial Accounting and Accounting Financial Accounting and Accounting Financial Financial Standards Standards Standards Standards Financial Financial Statements and Financial Reporting Financial Accounting and Accounting capital allocation capital Challenges Challenges Objectives Objectives Need to develop Need standards standards Parties Involved in Parties Standard Setting Standard Securities and Exchange Commission Commission American Institute of American CPAs CPAs Financial Financial Accounting Standards Board Standards Changing role of the Changing AICPA AICPA Generally Accepted Generally Accounting Principles Principles FASB Codification Issues in Financial Issues Reporting Reporting Political environment Expectations gap International International accounting standards accounting Ethics Financial Statements and Financial Reporting Financial Statements and Financial Reporting Financial Essential characteristics of accounting are: (1) the identification, measurement, and communication of financial information about (2) economic entities to (3) interested parties. Financial Statements and Financial Reporting Financial Statements and Financial Reporting Economic Entity Financial Statements Additional Information Financial Financial Information Balance Sheet President’s letter Income Statement Prospectuses, Statement of Cash Flows SEC Reporting Statement of Owners’ or Stockholders’ Equity News releases Accounting? Identifies and Measures and Note Disclosures Communicates Forecasts Environmental Reports Etc. GAAP Not GAAP Financial Statements and Financial Reporting Financial Statements and Financial Reporting Review What is the purpose of information presented in notes to the What is the purpose of information presented in notes to the financial statements? a. b. c. d. To provide disclosure required by generally accepted accounting principles. To correct improper presentation in the financial statements. To provide recognition of amounts not included in the totals of the financial statements. To present management’s responses to auditor comments. Accounting and Capital Allocation Accounting and Capital Allocation Accounting Resources are limited. Efficient use of resources often determines whether a business thrives. Illustration 1-1 Capital Allocation Process Financial Financial Reporting Reporting Information to help Information users with capital allocation decisions. allocation Users Capital Allocation Investors, creditors, Investors, and other users and The process of The determining how and at what cost money is allocated among competing interests. competing Challenges Facing Financial Accounting Challenges Facing Financial Accounting Challenges Nonfinancial Measurements Forward­looking Information Soft Assets Timeliness Objectives of Financial Accounting Objectives of Financial Accounting Financial reporting should provide information that: Financial reporting should provide information that: (a) is useful to present and potential investors and creditors and other users in making (a) is useful to present and potential investors and creditors and other users in making (a) is useful to present and potential investors and creditors and other users in making rational investment, credit, and similar decisions. rational investment, credit, and similar decisions. (b) helps present and potential investors and creditors and other users in assessing the (b) helps present and potential investors and creditors and other users in assessing the amounts, timing, and uncertainty of prospective cash receipts. amounts, timing, and uncertainty of prospective cash receipts. (c) clearly portrays the economic resources of an enterprise, the claims to those (c) clearly portrays the economic resources of an enterprise, the claims to those resources, and the effects of transactions, events, and circumstances that change resources, and the effects of transactions, events, and circumstances that change its resources and claims to those resources. its resources and claims to those resources. Need to Develop Standards Need to Develop Standards Need Various users need financial information The accounting profession has attempted to develop a set of standards that are generally accepted and universally practiced. Financial Statements Balance Sheet Income Statement Statement of Stockholders’ Equity Statement of Cash Flows Note Disclosure Generally Accepted Generally Accounting Principles (GAAP) (GAAP) Parties Involved in Standard Setting Parties Involved in Standard Setting Parties Three organizations: Securities and Exchange Commission (SEC) American Institute of Certified Public Accountants (AICPA) Financial Accounting Standards Board (FASB) Securities and Exchange Commission Securities and Exchange Commission Es ta b lis h e d b y fe d e ra l g o ve rn m e n t Ac c o untin g a n d re p o rting fo r p u b lic c o m p a nie s Securities Act of Securities Act of Securities Act of 1933 1933 Securities Act of Securities Act of 1934 1934 En c o u ra g e d p riva te s ta nd a rd ­s e tting b o d y S EC re q u ire s p u b lic c o m p a nie s to a d h e re to G AAP S EC O ve rs ig h t En fo rc e m e n t Auth o rity American Institute of CPAs American Institute of CPAs American Na tio na l p ro fe s s io na l o rg a n iza tio n Es ta b lis h e d th e fo llo wing : Committee on Committee on Accounting Procedures Accounting Procedures Accounting Principles Accounting Principles Board Board 1939 to 1959 1959 to 1973 Issued 51 Accounting Research Bulletins (ARBs) Issued 31 Accounting Principle Board Opinions (APBOs) Problem-by-problem approach failed Wheat Committee recommendations adopted in 1973 http://www.aicpa.org/ Financial Accounting Standards Board Financial Accounting Standards Board Financial Wheat Committee’s recommendations resulted in the creation of a the Financial Accounting Standards Board in 1973. Financial Accounting Financial Accounting Foundation Foundation Selects members of the FASB Funds their activities Exercises general oversight. Financial Accounting Financial Accounting Standards Board Standards Board Mission to establish and improve standards of financial accounting and reporting. Financial Accounting Financial Accounting Standards Advisory Standards Advisory Council Council Consult on major policy issues. Financial Accounting Standards Board Financial Accounting Standards Board Missions is to establish and improve standards of financial accounting and Missions is to establish and improve standards of financial accounting and reporting. Differences between FASB and APB include: Smaller Membership Full­time, Remunerated Membership Greater Autonomy Increased Independence Broader Representation http://www.fasb.org/ Due Process Due Process FASB relies on two basic premises: FASB relies on two basic premises: Responsive to entire economic community (2) Operate in full view of the public (1) 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 Types of Pronouncements Types of Pronouncements Issued by the FASB: Issued by the FASB: Standards, Interpretations, and Staff Positions. Financial Accounting Concepts Emerging Issues Task Force Statements Changing Role of AICPA 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. Generally Accepted Accounting Principles Generally Accepted Accounting Principles Generally T h o s e p rinc ip le s th a t h a ve substantial authoritative support. Ma jo r s o u rc e s o f G AAP a re : FASB Standards, Interpretations, and Staff Positions APB Opinions AICPA Accounting Research Bulletins Issues in Financial Reporting Issues in Financial Reporting Issues Standard Setting in a Political Environment Ac c o un tin g s ta n d a rd s a re a s m uc h a p ro d u c t o f p o litic a l a c tio n a s th e y a re o f c a re ful lo g ic o r e m p iric a l find in g s . Standard Setting Standard Setting Business Entities Business Entities CPAs and CPAs and Accounting Firms Accounting Firms AICPA (AcSEC) AICPA (AcSEC) Academicians Academicians Investing Public Investing Public Illustration 1-6 User Groups that Influence Accounting Standards Financial Financial Community Community FASB FASB FASB Preparers Preparers (e.g., FEI) (e.g., FEI) Government Government (SEC, IRS, other (SEC, IRS, other aagencies) gencies) Industry Industry Associations Associations Accounting standards, interpretations, and bulletins Issues in Financial Reporting Issues in Financial Reporting Issues Expectation Gap Wh a t th e p ub lic th in ks a c c o u nta n ts s h o u ld d o vs . wh a t a c c o u nta n ts th in k th e y c a n d o . Difficult to close Sarbanes­Oxley Act (2002) Public Company Accounting Oversight Board (PCAOB) Issues in Financial Reporting Issues in Financial Reporting Issues International Accounting Standards T wo s e ts o f s ta nd a rd s a c c e p te d fo r in te rn a tio na l us e : 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. Issues in Financial Reporting Issues in Financial Reporting Issues Ethics in the Environment of Financial Accounting In a c c o un tin g , we fre q u e ntly e n c o u nte r e th ic a l d ile m m a s . GAAP does not always provide an answer Doing the right thing is not always easy or obvious Diversity in Practice Inte rna tio na l s ta nd a rd s a re re fe rre d to a s Inte rna tio na l Fina nc ia l R e p o rting S ta nd a rd s (IFR S ) , d e ve lo p e d b y th e Inte rna tio na l Ac c o unting S ta nd a rd s Bo a rd (IAS B) . R e c e nt e ve nts in th e g lo b a l c a p ita l m a rke ts h a ve und e rs c o re d th e im p o rta nc e o f fina nc ia l d is c lo s ure a nd tra ns p a re nc y no t o nly in th e Unite d S ta te s b ut in m a rke ts a ro und th e wo rld . As a re s ult, m a ny a re e xa m ining wh ic h a c c o unting a nd fina nc ia l d is c lo s ure rule s s h o uld b e fo llo we d . U.S s ta nd a rd s , re fe rre d to a s g e ne ra lly a c c e p te d a c c o unting p rinc ip le s (G AAP ) , a re d e ve lo p e d b y th e Fina nc ia l Ac c o unting S ta nd a rd s Bo a rd (FAS B) . T h e fa c t th a t th e re a re d iffe re nc e s b e twe e n wh a t is in th is te xtb o o k (wh ic h is b a s e d o n U.S . s ta nd a rd s ) a nd IFR S s h o uld no t b e s urp ris ing b e c a us e th e FAS B a nd IAS B h a ve re s p o nd e d to d iffe re nt us e r ne e d s . Diversity in Practice T h e inte rna l c o ntro l s ta nd a rd s a p p lic a b le to S a rb a ne s ­O xle y (S O X ) a p p ly o nly to la rg e p ub lic c o m p a nie s lis te d o n U.S . e xc h a ng e s . T h e re is a c o ntinuing d e b a te a s to wh e th e r no n­U.S . c o m p a nie s s h o uld h a ve to c o m p ly with th is e xtra la ye r o f re g ula tio n. De b a te a b o ut inte rna tio na l c o m p a nie s (no n­U.S .) a d o p ting S O X ­ty p e s ta nd a rd s c e nte rs o n wh e th e r th e b e ne fits e xc e e d th e c o s ts . T h e c o nc e rn is th a t th e h ig h e r c o s ts o f S O X c o m p lia nc e a re m a king th e U.S . s e c uritie s m a rke ts le s s c o m p e titive . T h e te xtb o o k m e ntio ns a num b e r o f e th ic s vio la tio ns , s uc h a s Wo rld C o m , AIG , a nd Le h m a n Bro th e rs . T h e s e p ro b le m s h a ve a ls o o c c urre d inte rna tio na lly, fo r e xa m p le , a t S a ty a m C o m p ute r S e rvic e s (Ind ia ) , P a rm a la t (Ita ly ) , a nd R o ya l Ah o ld (th e Ne th e rla nd s ) . Chapter 2 - CONCEPTUAL FRAMEWORK Chapter UNDERLYING FINANCIAL ACCOUNTING 1.. 1 Describe the usefulness of a conceptual framework. 2. Describe the FASB’s efforts to construct a conceptual framework. Understand the objectives of financial reporting. Identify the qualitative characteristics of accounting information. Define the basic elements of financial statements. Describe the basic assumptions of accounting. Explain the application of the basic principles of accounting. Describe the impact that constraints have on reporting accounting information. 3. 4. 5. 6. 7. 8. Financial Accounting and Accounting Standards Financial Accounting and Accounting Standards Conceptual Conceptual Framework Framework Need Development First Level: Basic First Objectives Objectives Decision usefulness usefulness Information about Information economic resources resources Second Level: Second Fundamental Concepts Concepts Qualitative Qualitative characteristics characteristics Basic elements Third Level: Third Recognition and Measurement Measurement Basic assumptions Basic principles Constraints Conceptual Framework The Need for a Conceptual Framework To develop a coherent set of standards and rules To solve new and emerging practical problems Development of Conceptual Framework The FASB has issued six Statements of Financial Accounting The Concepts (SFAC) for business enterprises. SFAC No.1 - Objectives of Financial Reporting SFAC No.2 - Qualitative Characteristics of Accounting Information SFAC No.3 - Elements of Financial Statements (superceded by 6) SFAC No.5 - Recognition and Measurement in Financial Statements SFAC No.6 - Elements of Financial Statements (replaces SFAC No. 3) SFAC No.7 - Using Cash Flow Information and Present Value in Accounting Measurements SFAC No. Conceptual Framework The Framework is comprised of three levels: First Level = Basic Objectives Second Level = Qualitative Characteristics and Basic Elements Third Level = Recognition and Measurement Concepts. The FASB and the IASB have agreed on a joint project to develop a common and improved conceptual framework. ASSUMPTIONS ASSUMPTIONS PRINCIPLES CONSTRAINTS 1. Economic entity 1. Measurement 1. Cost-benefit 2. Going concern 2. Revenue recognition 2. Materiality 3. Monetary unit 3. Expense recognition 3. Industry practice 4. Periodicity 4. Full disclosure 4. Conservatism QUALITATIVE QUALITATIVE CHARACTERISTICS CHARACTERISTICS Relevance Reliability Comparability Illustration 2-7 Conceptual Framework for Financial Reporting Consistency 1. 1. 2. 2. 3. 3. Third level ELEMENTS Assets, Liabilities, and Equity Investments by owners Distribution to owners Comprehensive income Revenues and Expenses Gains and Losses OBJECTIVES Useful in investment and credit decisions and Useful in assessing future cash flows future About enterprise resources, claims to resources, and changes in them changes Second level First level First Level: Basic Objectives First Finaanc ia l re ppoortin gg s hhoould p ro vid ee in fo rm aatio n th aat: Fin nc ia l re rtin s uld p ro vid in fo rm tio n th t: Fin ((a) is useful to present and potential investors and creditors and other users a) (a) is useful to present and potential investors and creditors and other users in making rational investment, credit, and similar decisions. in making rational investment, credit, and similar decisions. ((b) helps present and potential investors and creditors and other users in b) helps present and potential investors and creditors and other users in aassessingthe amounts, timing, and uncertainty of prospective cash ssessing the amounts, timing, and uncertainty of prospective cash rreceipts. eceipts. ((c) portrays the economic resources of an enterprise, the claims to those c) portrays the economic resources of an enterprise, the claims to those rresources,and the effects of transactions, events, and circumstances esources, and the effects of transactions, events, and circumstances that change its resources and claims to those resources. that change its resources and claims to those resources. Second Level: Fundamental Concepts Second Question: How does a company choose an acceptable accounting method, the amount and types of information to disclose, and the format in which to present it? Answer: By determining which alternative provides the most useful information for decision-making purposes (decision usefulness). Second Level: Fundamental Concepts Qualitative Characteristics “The FASB identified the Qualitative Characteristics of accounting information that distinguish better (more useful) information from inferior (less useful) information for decisionmaking purposes.” Second Level: Qualitative Characteristics Second Illustration 2-2 Hierarchy of Accounting Qualities Second Level: Fundamental Concepts Understandability A company may present highly relevant and reliable information, however it was useless to those who do not understand it. ASSUMPTIONS ASSUMPTIONS PRINCIPLES CONSTRAINTS 1. Economic entity 1. Measurement 1. Cost-benefit 2. Going concern 2. Revenue recognition 2. Materiality 4. Full disclosure 4. Conservatism Relevance and Reliability practice 3. Expense recognition 3. Industry Relevance and Reliability 3. Monetary unit 4. Periodicity QUALITATIVE QUALITATIVE CHARACTERISTICS CHARACTERISTICS Relevance Reliability Comparability Illustration 2-7 Conceptual Framework for Financial Reporting Consistency 1. 1. 2. 2. 3. 3. Third level ELEMENTS Assets, Liabilities, and Equity Investments by owners Distribution to owners Comprehensive income Revenues and Expenses Gains and Losses OBJECTIVES Useful in investment and credit decisions and Useful in assessing future cash flows future About enterprise resources, claims to resources, and changes in them changes Second level First level Second Level: Qualitative Characteristics Second Primary Qualities: Relevance – making a difference in a decision. Predictive value Feedback value Timeliness Reliability Verifiable Representational faithfulness Neutral - free of error and bias In the proposed converged conceptual framework, reliability will be replaced with “faithful representation” as one of the primary qualitative characteristics that must be present for information to be useful. ASSUMPTIONS ASSUMPTIONS PRINCIPLES CONSTRAINTS 1. Economic entity 1. Measurement 1. Cost-benefit 2. Going concern 2. Revenue recognition 2. Materiality 4. Full disclosure 4. Conservatism Comparability and Consistency 3. Expense recognition 3. Industry practice Comparability and Consistency 3. Monetary unit 4. Periodicity QUALITATIVE QUALITATIVE CHARACTERISTICS CHARACTERISTICS Relevance Reliability Comparability Illustration 2-7 Conceptual Framework for Financial Reporting Consistency 1. 1. 2. 2. 3. 3. Third level ELEMENTS Assets, Liabilities, and Equity Investments by owners Distribution to owners Comprehensive income Revenues and Expenses Gains and Losses OBJECTIVES Useful in investment and credit decisions and Useful in assessing future cash flows future About enterprise resources, claims to resources, and changes in them changes Second level First level Second Level: Qualitative Characteristics Second Secondary Qualities: Comparability – Information that is measured and reported in a similar manner for different companies is considered comparable. Consistency - When a company applies the same accounting treatment to similar events from period to period. ASSUMPTIONS ASSUMPTIONS PRINCIPLES CONSTRAINTS 1. Economic entity 1. Measurement 1. Cost-benefit 2. Going concern 2. Revenue recognition 2. Materiality 4. Full disclosure 4. Conservatism 3. Monetary unit 4. Periodicity Basic Elements 3. Industry practice 3. Expense recognition Basic Elements QUALITATIVE QUALITATIVE CHARACTERISTICS CHARACTERISTICS Relevance Reliability Comparability Illustration 2-7 Conceptual Framework for Financial Reporting Consistency 1. 1. 2. 2. 3. 3. Third level ELEMENTS Assets, Liabilities, and Equity Investments by owners Distribution to owners Comprehensive income Revenues and Expenses Gains and Losses OBJECTIVES Useful in investment and credit decisions and Useful in assessing future cash flows future About enterprise resources, claims to resources, and changes in them changes Second level First level Second Level: Basic Elements Concepts Statement No. 6 defines ten interrelated elements that relate to measuring the performance and financial status of a business enterprise. “Moment in Time” Assets Liabilities Equity “Period of Time” Investment by owners Investment Distribution to owners Comprehensive income Revenue Expenses Gains Losses Third Level: Recognition and Measurement Third The FASB sets forth most of these concepts in its Statement of Financial Accounting Concepts No. 5, “Recognition and Measurement in Financial Statements of Business Enterprises.” ASSUMPTIONS PRINCIPLES CONSTRAINTS 1. Economic entity 1. Measurement 1. Cost-benefit 2. Going concern 2. Revenue recognition 2. Materiality 3. Monetary unit 3. Expense recognition 3. Industry practice 4. Periodicity 4. Full disclosure 4. Conservatism Third Level: Assumptions Economic Entity – company keeps its activity separate from its owners and other businesses. Going Concern - company to last long enough to fulfill objectives and commitments. Monetary Unit - money is the common denominator. Periodicity - company can divide its economic activities into time periods. Third Level: Assumptions Third Brief Exercise 2-4: Identify which basic assumption of accounting is best described in each item below. (a) The economic activities of KC Corporation are divided into 12-month periods for the purpose of issuing annual reports. (b) Solectron Corporation, Inc. does not adjust amounts in its financial statements for the effects of inflation. (c) Walgreen Co. reports current and noncurrent classifications in its balance sheet. (d) The economic activities of General Electric and its subsidiaries are merged for accounting and reporting purposes. Periodicity Monetary Unit Going Concern Economic Economic Entity Entity Third Level: Principles Measurement – The most commonly used measurements are based on historical cost and fair value. Issues: Historical cost provides a reliable benchmark for measuring historical trends. Fair value information may be more useful. Recently the FASB has taken the step of giving companies the option to use fair value as the basis for measurement of financial assets and financial liabilities. Reporting of fair value information is increasing. Third Level: Principles Revenue Recognition - generally occurs (1) when realized or realizable and (2) when earned. Exceptions: Illustration 2-4 Timing of Revenue Recognition Third Level: Principles Expense Recognition - “Let the expense follow the revenues.” - Matching of expenses to revenues. Illustration 2-5 Expense Recognition Third Level: Principles Full Disclosure – providing information that is of sufficient importance to influence the judgment and decisions of an informed user. Provided through: Financial Statements Notes to the Financial Statements Supplementary information Third Level: Principles Third Brief Exercise 2-5: Identify which basic principle of accounting is best described in each item below. Revenue Revenue (a) KC Corporation reports revenue in its income statement Recognitio Recognitio when it is earned instead of when the cash is collected. n (b) Yahoo, Inc. recognizes depreciation expense for a machine over the 2-year period during which that machine helps the company earn revenue. (c) Oracle Corporation reports information about pending lawsuits in the notes to its financial statements. (d) Eastman Kodak Company reports land on its balance sheet at the amount paid to acquire it, even though the estimated fair market value is greater. Expense Expense Recognitio Recognitio n Full Full Disclosure Disclosure Measurement Third Level: Constraints Third Cost Benefit – the cost of providing the information must be weighed against the benefits that can be derived from using it. Materiality - an item is material if its inclusion or omission would influence or change the judgment of a reasonable person. Industry Practice - the peculiar nature of some industries and business concerns sometimes requires departure from basic accounting theory. Conservatism – when in doubt, choose the solution that will be least likely to overstate assets and income. Third Level: Constraints Brief Exercise 2-7: What accounting constraints are illustrated by the items below? (a) KC, Inc. reports agricultural crops on its balance sheet at market value. Industry Industry Practice Practice (b) Rafael Corporation does not accrue a contingent lawsuit gain of $650,000. Conservatism (c) Willis Company does not disclose any information in the notes to the financial statements unless the value of the information to users exceeds the expense of gathering it. (d) Favre Corporation expenses the cost of wastebaskets in the year they are acquired. CostBenefit Materiality LO 8 Both the IASB and FASB have similar measurement principles, based on historical cost and fair value. Although both GAAP and IFRS are increasing the use of fair value to report assets, at this point IFRS has adopted it more broadly. GAAP has a concept statement to guide estimation of fair values when market­related data is not available (Statement of Financial Accounting Concepts No. 7, “Using Cash Flow Information and Present Value in Accounting”). The IASB is considering a proposal to provide expanded guidance on estimating fair values. The monetary unit assumption is part of each framework. However, the unit of measure will vary depending on the currency used in the country in which the company is incorporated. The economic entity assumption is also partof each framework although some cultural differences result in differences in its application. For example, in Japan many companies have formed alliances that are so strong that they act similar to related corporate divisions although they are not actually part of the same company. ...
View Full Document

This note was uploaded on 11/29/2011 for the course ACC 375 taught by Professor Lash during the Spring '11 term at Rutgers.

Ask a homework question - tutors are online