Intermediate Accounting - Chap001 docx

Cash Versus Accrual AccountingCash Basis Accounting Revenue is recognized when cash is received.. Cash Versus Accrual Accounting Cash Basis Accounting Carter Company has sales on accoun

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Theoretical Structure

of Financial Accounting

1

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Learning Objectives

Describe the function and primary focus of financial accounting.

Financial Accounting Environment

Profit-oriented companies

Not-for-profit entities Households

Providers of Financial Information

External User Groups

Investors Creditors Employees Labor unions Customers Suppliers Government agencies Financial intermediaries

Relevant

Financial Information

Financial Accounting Environment

Relevant financial information is provided

primarily through financial statements

and related disclosure notes

 Balance Sheet

 Income Statement

 Statement of Cash Flows

 Statement of Shareholders’ Equity

Financial Reporting

A sole proprietorship

is owned by a single individual.

A sole proprietorship

is owned by a single individual.

A partnership is owned by two or more individuals.

A partnership is owned by two or more individuals.

A corporation is owned

by stockholders, frequently numbering

in the tens of thousands

in large corporations.

A corporation is owned

by stockholders, frequently numbering

in the tens of thousands

in large corporations.

A highly-developed system of financial reporting is necessary to communicate financial information from a corporation

to its many shareholders.

A highly-developed system of financial reporting is necessary to communicate financial information from a corporation

to its many shareholders.

Investment-Credit Decisions

A Cash Flow Perspective

Corporate shareholders receive cash from

their investments through

 Periodic dividend distributions from the

corporation.

 The ultimate sale of the ownership shares of

stock.

Accounting information should help

investors evaluate the amount, timing,

and uncertainty of the enterprise’s

future cash flows

A Cash Flow Perspective

Learning Objectives

Explain the difference between cash and accrual accounting.

Cash Versus Accrual Accounting

Cash Basis Accounting Revenue is recognized when cash is received Expenses are recognized when cash is paid.

Cash Versus Accrual Accounting

Cash Basis Accounting

Carter Company has sales on account totaling

$100,000 per year for three years Carter collected

$50,000 in the first year and $125,000 in the second

and third years The company prepaid $60,000 for

three years’ rent in the first year Utilities are $10,000

per year, but in the first year only $5,000 was paid

Payments to employees are $50,000 per year.

Let’s look at the cash flows.

Cash Versus Accrual Accounting

Cash Basis Accounting

Cash Versus Accrual Accounting

Cash flows in any one year may not be a

predictor of future cash flows.

Cash Basis Accounting

Cash Versus Accrual Accounting

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

Let’s reconsider the Carter Company information

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

Let’s reconsider the Carter Company information

Cash Versus Accrual Accounting

The Development of Financial Accounting

and Reporting Standards

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

Historical Perspective and Standards

Securities and Exchange Commission

Current Standard Setting - FASB

www.fasb.org

 Supported by the Financial Accounting

Foundation.

 Seven full-time, independent voting members

serving for 10 years.

 Answerable only to the Financial Accounting

Foundation.

 Members not required to be CPAs.

Learning Objectives

Explain why the establishment of accounting standards is characterized

as a political process.

Establishment of Accounting Standards

www.sec.gov

American Accounting Association

www.aaa-edu.org

Governmental Accounting Standards Board

www.gasb.org

Financial Executives

International

www.fei.org

FASB’s Standard-Setting Process

 Identification of problem.

 The task force.

 Research and analysis.

International Accounting Standards

Board (IASB)

 Established in 1973 to narrow the

range of differences in accounting

standards.

 Increase in international trade has

motivated the IASB to attempt to

eliminate alternative accounting

treatments

Role of the Auditor

Independent intermediary to help insure that

management has in fact appropriately

applied GAAP

Financial Reporting Reform

As a result of numerous financial scandals,

Congress passed the Public Company Public Company

Accounting Reform and Investor Protection Act of 2002, commonly referred to as the

Sarbanes-Oxley Act for the two congressmen

who sponsored the bill

Learning Objectives

Explain the purpose of the FASB’s conceptual framework

The Conceptual Framework

 Maintain consistency among standards.

 Resolve new accounting problems.

 Provide user benefits.

Learning Objectives

Identify the objectives of financial reporting, the

qualitative characteristics of accounting information, and the elements of financial

The Conceptual Framework

Recognition and Measurement Criteria

(SFAC No 5)

Environment Implementation Implementation

assumptions principles constraints

Objectives of Financial Reporting

(SFAC No 6)

To provide information:

Useful for investor and creditor decisions.

That helps predict cash flows.

About economic resources, claims to resources, and changes in resources and claims.

Elements Recognition and Measurement

Continued

Assets Liabilities Equity Investments by Owners Distributions to owners

Revenues Expenses Gains Losses Comprehensive Income

Recognition and Measurement Concepts

Assumptions Economic entity Going concern Periodicity Monetary unit Principles Historical cost Realization Matching Full Disclosure

Objectives

Financial Statements

Balance sheet Income statement Statement of cash flows Statement of shareholders’ equity

Relevance Reliability

Predictive

Value

Feedback Value Timeliness Verifiability Neutrality

Representational Faithfulness

Comparability Consistency

Accounting Information

Decision Usefulness

Practical Constraints to Achieving

Desired Qualitative Characteristics

Cost Effectiveness

Cost Effectiveness Materiality

Conservatism

Assets and Liabilities

Assets are probable future economic benefits

obtained or controlled by a particular entity as a

result of past transactions or events.

Liabilities are probable future sacrifices of

economic benefits arising from present

obligations of a particular entity to transfer or

provide services to other entities in the future as

a result of past transactions or events.

SFAC No 6

Equity

Equity, or net assets, called shareholders’

equity or stockholders’ equity for a corporation, is the residual interest in the

assets of an entity that remains after

deducting liabilities

Investments and Distributions

Investments by owners are increases in

equity resulting from transfers of resources (usually cash) to a company in exchange

for ownership interest

Distributions to owners are decreases in

equity resulting from transfers to the

owners

SFAC No 6

Revenues

Revenues are inflows or other enhancements of assets or settlements of

liabilities from delivering or producing

goods, rendering services, or other activities that constitute the entity’s ongoing major, or central, operations

Expenses are outflows or other using up of assets or incurrences of liabilities during a

period from delivering or producing goods,

rendering services, or other activities that

constitute the entity’s ongoing major, or

central, operations

SFAC No 6

Gains and Losses

Gains are increases in equity peripheral, or

incidental, transactions of an entity

Losses represent decreases in equity arising from peripheral, or incidental, transactions

of an entity

Comprehensive Income

Comprehensive income is the change in equity

of a business enterprise during a period from

transactions and other events and circumstances from nonowner sources It includes all changes in equity during a period

except those resulting from investments from

owners and distributions to owners

Recognition and Measurement Concepts

Assumptions Description

Economic entity All economic events identified with a particular

economic entity.

Going concern Business entity will continue to operate indefinitely.

Periodicity Life of company is divided into time periods to provide

and reasonable certainty of collection exists.

Matching Expenses recognized in same period as related revenue Full disclosure Information that could change user decisions should be

included.

The function of financial accounting is to

identify, measure and communicate

financial information about economic

entities to interested parties

a True

b False

The function of financial accounting is to

identify, measure and communicate

financial information about economic

entities to interested parties

a True

b False

Accrual accounting provides a better

indication of ability to generate cash flows

than does information limited to the

financial effects of cash receipts and cash

payments

a True

b False

Accrual accounting provides a better

indication of ability to generate cash flows

than does information limited to the

financial effects of cash receipts and cash

payments

a True

b False

The primary objective of accrual basis

accounting is the measurement of income

a True

b False

The primary objective of accrual basis

accounting is the measurement of income

a True

b False

Generally accepted accounting principles

include both standards set by various rule

making bodies and certain accounting

practices that have evolved over time

a True

b False

Generally accepted accounting principles

include both standards set by various rule

making bodies and certain accounting

practices that have evolved over time

a True

b False

The major financial accounting standard

setting body is the

a Accounting Principles Board

b Securities and Exchange Commission

c Financial Accounting Standards Board

d American Institute of CPAs

The major financial accounting standard

setting body is the

a Accounting Principles Board

b Securities and Exchange Commission

c Financial Accounting Standards Board

d American Institute of CPAs

The Financial Accounting Standards

Board develops accounting and reporting

standards independent of public, business

and political pressures

a True

b False

The Financial Accounting Standards

Board develops accounting and reporting

standards independent of public, business

and political pressures

a True

b False

Ethics in Accounting

 To be useful, accounting information must be

objective and reliable

 Management may be under pressure to report

desired results and ignore or bend existing rules.

Model for Ethical Decisions

 Determine the facts of the situation.

 Identify the ethical issue and the stakeholders.

 Identify the values related to the situation.

 Specify the alternative courses of action.

 Evaluate the courses of action.

 Identify the consequences of each course of action.

 Make your decision and take any indicated action.

End of Chapter 1