Intermediate accounting 19th by stice stice 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 reaso

Intermediate

Accounting

James D Stice Earl K Stice

PowerPoint presented by Douglas Cloud Professor Emeritus of Accounting, Pepperdine

Financial Reporting

Chapter 1

19 th

Edition

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.

• Accounting information is used in making

decisions about how to allocate scarce

resources

• Although accountants place much emphasis

on reporting what has already occurred, this past information is intended to be useful in

making economic decisions about the future.Key features in this definition of accounting:

Definition of Accounting

Users of Accounting Information

• Stakeholders are all parties interested in the

financial health of a company.

• Internal users are stakeholders who make decisions that directly affect the internal

operations of the enterprise.

• External users are stakeholders who make decisions concerning their relationship to the enterprise.

Users of Accounting Information

1 Management accounting is concerned

primarily with financial reporting for internal users, especially management.

2 Financial accounting focuses on the

development and communication of

financial information for external users.

a Helps users in determining whether a

company’s operations are profitable enough to justify additional funding.

(continued)

b Helps users in determining how risky

a company’s operations are in order

to determine what rate of return is

necessary to compensate capital

providers for the investment risk.

Users of Accounting Information

company and, if so,

what interest rate to

company and, if so,

what interest rate to

charge

Investors

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

External Investors

The balance sheet reports, as of a

certain point in time, the resources

of a company (the assets), the

company’s obligations (the

liabilities), and the equity of the

owners.

General-Purpose Financial

Statements

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, which is called net

income.

(continued)

General-Purpose Financial

Statements

The statement of cash flows

reports, for a certain interval, the

amount of cash generated and

consumed by a company through

the following three types of

activities: operating, financing, and

investing activities.

General-Purpose Financial

Statements

Accounting estimates and

judgments are outlined in the notes

to financial statements In

addition, the notes contain

supplemental information as well as

information about items not

included in the financial statements.

General-Purpose Financial

Statements

Auditor’s Role

• Auditors, working independently of a

company’s management and internal

accountants, examine the financial

statements.

• They issue an auditor’s opinion about

the fairness of the statements and their

adherence to proper accounting

principles.

The FASB

• The Financial Accounting Standards

Board (FASB) sets accounting

standards in the United States.

• The FASB is a private-sector body and

has no legal authority.

• The issuance of new accounting

standards is preceded by a lengthy public discussion.

(continued)

• The Emerging Issues Task Force

(EITF) works under the direction of the FASB.

• The EITF formulates a timely expert

consensus on how to handle new

issues not yet covered in FASB

pronouncements.

The FASB

• The Securities and Exchange

Commission (SEC) was created by the

1933 Securities Act to protect the interests

of investors by ensuring full and fair

disclosure.

• It was given specific legal authority to

establish accounting standards for

companies desiring to publicly issue shares

in the United States.

(continued)

The FASB

• The SEC has generally allowed the

private-sector organizations to make the accounting standards in the United States (commonly referred to as generally

accepted accounting principles

(GAAP) ).

The FASB

• The Financial Accounting Standards

Board (FASB) is currently recognized as the private-sector body responsible for the

establishment of U.S accounting standards

• The FASB was organized in 1973, replacing the Accounting Principles Board (APB)

• Five full-time members are drawn from a

variety of backgrounds—auditing, corporate accounting, financial services, and academia

(continued)

The FASB

• Appointment of new Board members is

done by the Financial Accounting

• The major functions of the FASB are to

study issues and to establish accounting

standards.

• These standards are published as

Accounting Standards Updates.

• The FASB has also issued Statements of

Financial Accounting Concepts that

provide a framework within which specific accounting standards can be developed.

The FASB

FASB “Due Process”

1 FASB staff assembles background information

and the Board holds public meetings before a decision is made to even add a project to the FASB’s formal agenda

2 After more study and further hearings, the

Board often issues a report summarizing its

Preliminary Views

3 Interested parties are invited to comment either

in writing or orally at a public hearing

4 After comments from interested parties have

been evaluated, the Board meets as many

times as necessary to resolve the issues

5 From these meetings, the Board develops an

Exposure Draft of a statement that includes

specific recommendations for financial

accounting and reporting

6 After 60 days or longer, if the topic is a major

one, all comments are reviewed by the staff and the Board

(continued)

FASB “Due Process”

7 Further deliberation of the Board leads to either

the issuance of an Accounting Standards

Update, a revised Exposure Draft, or, in some cases, abandonment of the project

8 The final statement not only sets forth the actual

standards but also establishes the effective

date and method of transition

9 Currently, a simple majority (three out of five) is

required for approval of an Exposure Draft or a

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

Force (EITF).

• The EITF assists the FASB in the early

identification of emerging issues that affect financial reporting.

Emerging Issue Task Force

• The official source of U.S GAAP is called the FASB Accounting Standards

Codification (ASC)

• Prior to launching of the FASB ASC in July

2009, finding a specific accounting rule on a specific topic involved a primitive hunt-and- peck strategy.

FASB Accounting Standards

Codification

Securities and Exchange

• It requires companies to furnish various

financial statements, and other periodic

information about significant events

• The SEC requires companies to have their

external financial statements audited by

independent accountants

(continued)

• In addition to the SEC’s rules and interpretive releases, the SEC staff issues Staff

Accounting Bulletins that represent practices followed by the staff administering SEC

disclosure requirements

• The auditors of SEC-required financial

information must be registered and periodically inspected by the Public Company

Accounting Oversight Board (PCAOB)

Securities and Exchange

Commission (SEC)

American Institute of Certified Public

Accountants (AICPA)

• The American Institute of Certified Public

Accountants (AICPA) is the professional

organization of practicing certified public

accountants (CPAs) in the United States.

• It publishes the monthly journal, the Journal

• The AICPA is responsible for preparing and grading the Uniform CPA Examination.

• The American Accounting Association

(AAA) is an organization of accounting

professors.

• It sponsors national and regional meetings where accounting professors discuss

technical research and share innovative

teaching techniques and materials.

• It organizes working committees of

professors to study and comment on

American Accounting

Association

• One of the most significant actions of the AAA is to motivate and facilitate

curriculum revision to keep pace with the changes in the accounting profession.

• The AAA publishes a number of academic journals, including The Accounting

Review and Accounting Horizons

American Accounting

Association

Internal Revenue Service

• The Internal Revenue Service (IRS)

has the primary goal of equitably

collecting revenue.

• Although not the same, there are many areas where tax and financial accounting are closely related.

What is GAAP?

Historically, the Auditing Standards Board

of the AICPA has defined Generally

Accepted Accounting Principles (GAAP)

in the context of a phrase included in the

standard auditor’s opinion:

“present fairly…in conformity with generally

accepted accounting principles.”

International Accounting

Standards Board

• The international nature of business requires companies to be able to make their financial statements understandable to users all over the world.

• In an attempt to harmonize conflicting

standards, the International Accounting

Standards Board (IASB) was formed in

1973 to develop worldwide accounting

standards

• Accounting standards issued by the IASB are referred to as International Financial

Reporting Standards (IFRS) if issued since

2001, and International Accounting

Standards (IAS) if issued prior to 2001

• In 2008 the SEC began allowing non-U.S

companies with shares trading on U.S stock exchanges to issue their financial reports using IASB standards

(continued)

International Accounting

Standards Board

• The SEC is considering whether to allow

U.S companies to use IASB standards,

rather than FASB standards, in the financial reports that they provide to their U.S

stockholders

• If this happens, the FASB may cease to

exist

• The SEC “work plan” does not envision a

U.S switch to IFRS until 2015 at the earliest

International Accounting

Standards Board

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.

• The conceptual framework provides a guide for analyzing and resolving emerging issues.

(continued)

In February 2000, the FASB issued the last of seven Statements of Financial Accounting Concepts, which provide the basis for the

4) Objectives of Financial Reporting by

Nonbusiness Organizations

5) Recognition and Measurement in

Financial Statements of Business

Enterprises

6) Elements of Financial Statements (a

replacement of No 3, broadened to

include not-for-profit as well as business

enterprises) (continued)

Concepts Statements

7) Using Cash Flow Information and Present

Value in Accounting

Concepts Statements

The seven Concepts Statements addressed four major areas:

(continued)

Concepts Statements

financial reporting?

qualities of useful financial information?

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

revenue? an expense?

Conceptual Framework

reporting: How should the objectives,

qualities, and elements of definitions be

implemented?

Recognition, Measurement,

and Reporting

• Recognition —Boiling down all the

estimates and judgments into one

number and using that number to make a journal entry.

• Disclosure —Skipping the journal entry

and just relying on the note to convey the information to users.

(continued)

• 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, a receivable must meet the

definition of an asset to be recorded and

reported on the balance sheet

• Disclosure is preferable to recognition in

situations in which relevant information cannot

Recognition, Measurement,

and Reporting

1 Historical cost

2 Current replacement cost

3 Fair value

4 Net realizable value

5 Present (or discounted) value

Five different measurement attributes are

currently used in practice.

(continued)

Recognition, Measurement,

and Reporting

Reporting—Included in the recommended

set of general-purpose financial statements are reports that show the following:

Balance Sheet

• Financial position at the end of the period

Recognition, Measurement,

and Reporting

• Financial position at the end of the period

• Earnings (net income) for the period

Reporting—Included in the recommended

set of general-purpose financial statements are reports that show the following:

Income Statement

(continued)

Recognition, Measurement,

and Reporting

• Financial position at the end of the period

• Earnings (net income) for the period

• Cash flows during the period

Reporting—Included in the recommended

set of general-purpose financial statements are reports that show the following:

Statement of cash

flows

Recognition, Measurement,

and Reporting

• Financial position at the end of the period

• Earnings (net income) for the period

• Cash flows during the period

• Investments by and distributions to

owners during the period

Reporting—Included in the recommended

set of general-purpose financial statements are reports that show the following:

(continued)

Statement of changes in owners’ equity

Recognition, Measurement,

and Reporting

• Financial position at the end of the period

• Earnings (net income) for the period

• Cash flows during the period

• Investments by and distributions to

owners during the period

• Comprehensive income (total non-owner

Reporting—Included in the recommended

set of general-purpose financial statements are reports that show the following:

Recognition, Measurement,

and Reporting

• Comprehensive income differs from

earnings in that it includes unrealized

gains and losses not recognized in

the income statement.

• In 1998, the FASB required

companies to provide, in at least one

place, information relating to

unrealized gains and losses.

(continued)

Recognition, Measurement,

and Reporting

The FASB conceptual framework is

influenced by five basic assumptions:

Impact of the Conceptual Framework

• The conceptual framework provides a

basis for consistent judgments by all

those involved in financial reporting.

• Related to the conceptual framework is the push toward more “principles-based” accounting standards.

Rules vs Principles

In July 2003, the SEC submitted a report to

Congress recommending that the FASB move toward “objectives-oriented standards” which

would have the following characteristics:

• Be based on an improved and consistently

applied framework

• Clearly state the accounting objective of the

standard