Intermediate accounting 17e stice skousen cengage chapter 01

Its function is to provide quantitative information, primarily financial in nature, about economic entities that is intended to be useful in making economic decisions—in making reasone

Financial Reporting

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Intermediate Accounting,17E

Definition of Accounting

“Accounting is a service activity Its function is to provide quantitative information, primarily financial

in nature, about economic entities that is intended to

be useful in making economic decisions—in making reasoned choices among alternative courses of

action.”

Statement of the Accounting Principles Board No 4, par 40.

Key Features of this Definition

environment.

information that is used in conjunction with

qualitative evaluations in making judgments.

allocate scarce resources.

economic decisions about the future.

Accounting—

Users of Accounting Information

• Stakeholders are all parties interested in the

financial health of a company

• Internal users make decisions that directly affect the internal operations of the enterprise

• External users make decisions concerning

their relationship to the enterprise

External Funding

primarily with financial reporting for internal users, especially management.

development and communication of financial information for external users.

whether to lend money

to the company and, if

so, what interest rate to

whether to lend money

to the company and, if

so, what interest rate to

charge.

Investors (both

existing stockholders and potential investors) need information

concerning the safety and profitability of their investment.

Investors (both existing stockholders and potential investors) need information

concerning the safety and profitability of their investment.

(the liabilities), and the

equity of the owners.

The balance sheet

(the liabilities), and the

equity of the owners.

The income statement

reports, for a certain

interval, the net assets

The income statement

reports, for a certain

interval, the net assets

generated through

business operations

(revenues), the net assets

consumed (the expenses),

and the difference (net

income).

Financial Reporting

The statement of cash

flows reports, for a

certain interval, the

The statement of cash

flows reports, for a

certain interval, the

Financial Reporting

Accounting estimates and

judgments are outlined in the

notes to financial statements

Auditor’s Role

• Auditors, working independently of a

company’s management and internal

accountants, examine the financial statements

fairness of the statements and their adherence

to proper accounting principles

• Created to protect the interests of investors by

ensuring full and fair disclosure.

• Granted legal authority to establishing GAAP.

• Has tended to defer setting GAAP to the accounting

profession.

Financial Accounting Standards

Board (FASB)

of U.S accounting standards (also known as GAAP).

backgrounds—auditing, corporate accounting, financial services, and academia.

firms or institutions prior to assuming membership on the Board.

Accounting Foundation (FAF).

Governmental Accounting

Standards Board (GASB)

The FAF is also responsible for selecting and supporting members of GASB The GASB was established in 1984 and sets financial accounting standards for state and local government entities

The Standard-Setting Process

• The major functions of the FASB are to study

accounting issues and to establish accounting

standards.

• These standards are published as Statements of

Financial Accounting Standards .

• The FASB has also issued Statements of Financial

Accounting Concepts that provide a framework

within which specific accounting standards can be developed.

FASB “Due Process”

1 FASB staff assembles background information.

2 The Board holds public meetings before a decision is

made to add a project to the FASB’s formal agenda.

3 After more study and further hearings, the Board often

issues a report summarizing its Preliminary Views.

4 Interested parties are invited to comment either in writing

or orally at a public hearing.

5 After comments from interested parties have been

evaluated, the Board meets as many times as necessary to resolves the issues.

(continues)

6 From these meetings, the Board developes an Exposure

Draft of a statement that includes specific

recommendations for financial and accounting reporting.

7 At the end of the exposure period, 30 days or longer, all

comments are viewed by the staff and the Board.

8 Further deliberation by the Board leads to either the

issuance of a Statement of Financial Accounting

Standards (if at least three of the members approve), a revised Exposure Draft, or abandonment of the project.

FASB “Due Process”

In an effort to overcome the methodical, sometimes slow, nature of the standard setting process, in 1984 the FASB

established the Emerging Issues Task

FASB in the early identification of

emerging issues that affect financial

reporting.

Emerging Issue Task Force

Securities and Exchange Commission

(SEC)

trading of securities by corporations to the

general public

financial statements and to have their external financial statements audited by independent accountants

Securities and Exchange Commission

(SEC)

• It is vitally interested in financial reporting and

the development of accounting standards.

• It brings to the Board’s attention emerging

problems that need to be addressed and sends

observers to meet with the EITF.

• It occasionally issues Staff Accounting Bulletins

American Institute of Certified Public

Accountants (AICPA)

• It is the professional organization of practicing certified

public accountants (CPAs) in the United States.

• It is responsible for preparing and grading the

Uniform CPA Examination.

American Accounting Association

(AAA)

professors

• It sponsors national and regional meetings where accounting professors discuss

technical research and share teaching techniques and materials.

• It organizes working committees of professors to study and

comment on accounting standards issues.

• It motivates and facilitates curriculum revision to keep pace

with the changes in the accounting profession.

American Accounting Association

(AAA)

• The AAA publishes a number of academic journals, including

The Accounting Review and Accounting Horizons.

Internal Revenue Service (IRS)

collecting revenue

areas where tax and financial accounting are closely related

What is GAAP?

(continues)

What is GAAP?

• Similar to FASB, IASB develops proposals,

circulates these among interested organizations,

receives feedback, and then issues a final

pronouncement.

• Board members are representatives from the United

States, the United Kingdom, France, Sweden, China, Australia, South Africa, and Japan.

(continues)

International Accounting Standards

Board (IASB)

• Accounting standards issued by the IASB are referred to as International Financial Reporting Standards (IFRSs) if issued since to 2001 and International Accounting Standards (IASs) if issued prior to 2001.

Conceptual Framework

• A strong theoretical foundation is essential if

accounting practice is to keep pace with a changing business environment.

• The conceptual framework plays a vital role in the

development of new standards and in the revision of previously issued standards.

• A conceptual framework provides a guide for future

practice.

Concepts Statements

• In 2000, FASB issued seven Statements of Financial

Accounting Concepts, which addressed four major areas:

1 Objectives: What are the purposes of financial reporting?

2 Qualitative characteristics: What are the qualities of

useful financial information?

3 Elements: What is an asset? a liability? a revenue? an

expense?

4 Recognition, measurement, and reporting: How should the

Objectives of Financial Reporting

Usefulness

Usefulness

Financial reporting should provide

information that is useful to present and potential investors and creditors and

other users in making rational

investment, credit, and similar decisions

Statement of Financial Accounting Concepts No 1, par 34.

Objectives of Financial Reporting

Understandability

Understandability

Financial reporting should provide

information that is understandable to one who has a reasonable knowledge of

accounting and business and who is willing

to study and analyze the information

presented

Investors and Creditors

While there are many potential users

of financial reports, the objectives are directed primarily toward investors

and creditors

Objectives of Financial Reporting

Assessing Future Cash Flows

Assessing Future Cash Flows

Financial reporting should provide

information that is useful in assessing

amounts, timing, and uncertainty (risk) of

Objectives of Financial Reporting

Evaluating Economic Resources

Evaluating Economic Resources

Financial reporting should also provide information about a company’s assets,

liabilities, and owners’ equity to help

investors, creditors, and others evaluate the financial strengths and weaknesses of the enterprise and its liquidity and

solvency

Objectives of Financial Reporting

Primary Focus on Earnings

Primary Focus on Earnings

Information about company earnings,

measured by accrual accounting,

generally provides a better basis for

forecasting future performance than does information about current cash receipts and disbursements

Qualitative Characteristics of

Accounting Information

Benefits Greater Than Costs

Benefits Greater Than Costs

The information must be worth more than the cost of producing it

Qualitative Characteristics of

Accounting Information

Relevance

Relevance

The information must “make a

difference.” It must carry the qualities of:

Qualitative Characteristics of

Accounting Information

Relevant information normally provides

value at the same time

Relevance

Relevance

Qualitative Characteristics of

Accounting Information

Timeliness is essential for information

to “make a difference” because if the information becomes available after the decision is made, it isn’t of much use

Relevance

Relevance

Qualitative Characteristics of

Accounting Information

Reliability Reliability

The information must be relatively free from error and represent what it claims to represent It must have:

Qualitative Characteristics of

Accounting Information

Verifiability implies consensus

Representational faithfulness means that there is agreement between a measurement and the economic activity or item that is

the concept of fairness

Reliability Reliability

Qualitative Characteristics of

Accounting Information

Comparability Comparability

The information must be relatable to a benchmark or standard The

comparison may be with data for other firms or it may be with similar

information for the same firm but for other periods of time

Qualitative Characteristics of

Accounting Information

Materiality Materiality

Is the item large enough to influence the decision of a user of information?

Quantitative guidance concerning

materiality is lacking, so managers and accountants must exercise judgment in determining whether an item is material

summarized as follows: When in

doubt, recognize all losses but don’t recognize any gains

• Recognition —Taking all the estimates and judgments

into one number and using that number to make a journal entry.

• Recognition Criteria —For an item to be formally

recognized, it must meet one of the definitions of the

elements of the financial statements.

– For example, revenue must meet the definition of

revenue to be recorded and reported on the income

statement.

• Disclosure —Skipping the journal entry and just relying

on the note to convey the information to users.

Five measurement attributes are:

the period

Included in the recommended set of general-purpose financial statements are reports that show the

following:

Reporting

Comprehensive income differs from earnings in that it includes unrealized gains and losses not recognized in the income statement

Full Disclosure Principle

For financial statements to be most

effective, all relevant information should

be presented in an unbiased,

understandable, and timely manner This

disclosure principle

The FASB conceptual framework is influenced

by five basic assumptions

Traditional Assumptions of the

Accounting Model

Economic Entity

Economic Entity

The business enterprise is viewed as a

distinct from its owners and any other business unit

In the absence of evidence to the

concern In other words, it is assumed that the enterprise will last indefinitely

Traditional Assumptions of the

Accounting Model

Arm’s-Length Transactions

Arm’s-Length Transactions

Transactions are assumed to occur

between independent parties, each of which is capable of protecting its own interests

Traditional Assumptions of the

Accounting Model

Stable Monetary Unit

Stable Monetary Unit

The stable monetary unit assumption

allows for the ignoring of changes in the dollar’s purchasing power resulting from inflation

Traditional Assumptions of the

Accounting Model

Accounting Period

Accounting Period

Because accounting information is

needed on a timely basis, the life of a business is divided into specific

accounting periods, usually one year

Pubic accountants do not work for a single business enterprise Rather, they provide a variety of services for many different

individuals and business clients

Careers in Financial

Accounting

Public Accounting

Public Accounting

A large business enterprise employs

financial accountants who are primarily

concerned with external financial reporting, management accountants who are primarily concerned with internal financial reporting, and tax accountants

Careers in Financial

Accounting

Corporate Accounting

Corporate Accounting

Careers in Financial

Accounting

Many students take accounting in

preparation for becoming a user of financial statements Credit analysts, investment

bankers, brokers, and business consultants need a strong working knowledge of

accounting as well as strong skills in

information technology

User (Analyst, Banker, Consultant)

User (Analyst, Banker, Consultant)