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Structure of Financial Accounting

Chapter 1

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Financial Accounting Environment

Financial
Information
Providers
Profit-oriented
companies

Not-for-profit
entities

External
User Groups

Relevant

Financial
Information

Investors
Creditors
Employees
Labor unions
Customers
Suppliers
Government
agencies
Financial
intermediaries

Relevant Financial Information

What we mean by relevant is information that
helps external users of financial statements
make decisions about the company.

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Investment-Credit Decisions
Accounting information should help investors and
creditors evaluate the amount, timing, and
uncertainty of the enterprises future cash flows.

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Financial Accounting Statements

Relevant financial information is
provided primarily through financial
statements:

Balance Sheet
Income Statement
Statement of Cash Flows
Statement of Shareholders Equity

AND related disclosure notes!

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And..
Since 2012, companies must either provide
A Statement of Other Comprehensive Income
immediately following the Income Statement
or
A combined Statement of Comprehensive
Income that includes the information normally
contained in both the Income Statement and the
Statement of Other Comprehensive Income.

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Forms of Business Organizations

AA sole
sole proprietorship
proprietorship
is
is owned
owned by
by aa
single
single individual.
individual.
AA partnership
partnership is
is
owned
owned by
by two
two or
or
more
more individuals.
individuals.
AA corporation
corporation is
is owned
owned
by
by shareholders.
shareholders.

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Business Forms
Only the corporate form of organization has a legal
existence i.e. is separate from its owners.
Nevertheless the economic entity accounting
principle requires that we keep business activities
separate from the activities of the ownership.

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Cash versus Accrual Accounting

Cash Basis Accounting
Revenue is recognized when cash is received.
Expenses are recognized when cash is paid.
(Generally NOT ACCEPTABLE GAAP)

Accrual Accounting
Revenue is recognized when earned.
Expenses are recognized when incurred.

Example Cash and Accrual Accounting

Cash Basis Accounting
C Corp. has sales on account of $100,000 per
year for three years. It collected $50,000 in the
first year and $125,000 in years two and three.
C

paid $60,000 for three years rent in year 1.

Utilities

are $10,000 per year; only $5,000 was

paid in year 1.

Payments to employees are $50,000 per year.

Lets look at the cash flows:

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Cash Basis Accounting

Cash flows in any one year may not be a predictor
of future cash flows.

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Accrual Basis Accounting

Net Income is considered a better indicator
of future cash flows.

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The Development of Financial

Accounting and Reporting Standards

Concepts,
principles, and
procedures
developed to meet the
needs of external
users (GAAP).

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Historical Perspective and Standards

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Current U. S. Standard Setting

Financial Accounting
Standards Board (FASB)
Supported by the Financial Accounting

Foundation
Seven full-time, independent voting

members
Members not required to be CPAs

Accessing GAAP
We can, with the codification of generally
accepted accounting principles, find the answers
to our GAAP questions all in one place, the FASB
codification website:
https://asc.fasb.org/home

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FASB Accounting Standards Codification

Integrated and organized all relevant accounting
pronouncements into a searchable, online database.

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FASBs Standard-Setting Process

Board receives recommendations for projects and

votes to add the project to its agenda.

FASB deliberates the issues at a series of public

meetings and then issues an Exposure Draft (ED).

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Board holds a public roundtable meeting on the ED.

Staff analyzes feedback and the Board redeliberates

the proposed revisions at public meetings .

Board issues a Standards Update describing

amendments to the Codification.

International Standard Setting

The main objective of the International Accounting

Standards Board (IASB) is to develop a single set of high
quality, understandable, and enforceable global accounting
standards to help participants in the worlds capital markets
and other users make economic decisions.

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U.S. and International Standard-Setters

U.S. GAAP

IFRS
International
Organization of
Securities Commissions
(IOSCO)
International Accounting
Standards Committee
Foundation (IASCF): 22
trustees
International Accounting
Standards Board (IASB):
14 members (12 fulltime; 2 part-time)

Regulatory oversight
provided by:

Securities Exchange
Commission (SEC)

Foundation providing
oversight, appointing
members, raising
funds:

Financial Accounting
Foundation (FAF): 20
trustees

Standard-setting
board:

Financial Accounting
Standards Board (FASB):
7 full-time members

Advisory council
providing input on
agenda and projects:

Financial Accounting
Standards Advisory
Council (FASAC): 30-40
members

Standards Advisory
Council (SAC): 30-40
members

Group to deal with

emerging issues:

Emerging Issues Task

Force (EITF): 15
members

International Financial
Reporting Interpretations
Committee (IFRIC): 14
members

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Efforts to Converge U.S. and

International Standards

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Issues and Concerns:

Desire for a single set of global standards
Need for standards that are customized to fit stringent legal
and regulatory requirements of U.S.
Possible differences in implementation and enforcement

Progress:
Sept. 2002: FASB and IASB sign Norwalk Agreement.
Nov. 2008: SEC issues a Roadmap with milestones.
May 2011: SEC issues discussion paper describing a
condorsement approach.
Nov. 2011: SEC issues two studies comparing U.S. GAAP to
IFRS and analyzing how IFRS are applied globally.
Dec. 2011: SEC postpones final determination until ??????

Role of the Auditor

Auditors: independent CPAs who provide
assurance to outside decision-makers that
management has appropriately applied GAAP in
preparing the companys financial statements.

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Financial Reporting Reform

As a result of major financial scandals, Congress
passed the Public Company Accounting Reform and
Investor Protection Act of 2002,
2002 (Sarbanes-Oxley).
The goal was to restore credibility and investor
confidence in the financial reporting process.

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The Conceptual Framework-Purpose

The Conceptual Framework provides the
underlying foundation for accounting standards.

FASB Conceptual Framework

(Statements of Financial Accounting Concepts)
Objectives of Financial Reporting (SFAC 1, replaced
by SFAC 8)
Qualitative Characteristics (SFAC 2, replaced by SFAC
8)
Elements of Financial Statements (SFAC 3, replaced
by SFAC 6)

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The Conceptual Framework

Objective
To provide financial information
that is useful to capital providers.

Qualitative
Characteristics

Elements

Constraints

Financial
Statements

Recognition and
Measurement
Concepts

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Elements of Financial Statements I

Elements of Financial Statements II

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Revenue Recognition: Realization

Two Criteria:
1.Earnings process is complete or virtually
complete.
2.Reasonable certainty as to the collectability of
the asset to be received (usually cash).

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Expense Recognition: Matching

The matching principle requires that all

expenses incurred in generating revenue for a
period also be recognized in the same period.

Ethics in Accounting
For financial information to be useful, it should

possess the qualities of relevance and faithful

representation.
Management however, may be under pressure to

report desired results and be tempted to ignore or

bend existing rules.

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Evolving U.S. GAAP

U.S. GAAP has been evolving from an emphasis on
revenues and expenses to an emphasis on assets
and liabilities.
Revenue/Expense Approach: Emphasize principles
for recognizing revenues and expenses.

Asset/Liability Approach: Emphasis on recognizing

assets and liabilities first, and then recognize and
measure the revenues, expenses, gains, and losses
needed to account for the changes in assets and
liabilities from the previous measurement date.

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Evolution of Accounting Principles

The Asset/Liability Approach
Measure assets and liabilities that
exist at a balance sheet date.
Recognize revenues, expenses, gains,
and losses needed to account for the
changes in assets and liabilities from the
previous balance sheet date.

The focus on assets and liabilities has led to

increased interest on fair value measurement.

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Underlying Assumptions and

Accounting Principles

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And Since this is the End of the

Chapter..
Goodbye for Now.

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