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  • 1. Financial Reporting Chapter 1 S t I c e | S t I c e | S k o u s e n Intermediate Accounting 16E
  • 2. Learning Objectives
    • Describe the purpose of financial reporting and identify the primary financial statements.
    • Explain the function of accounting standards and describe the role of the FASB in setting those standards in the United States.
    • Recognize the importance of the SEC, AICPA, AAA and IRS to financial reporting.
  • 3. Learning Objectives (cont.)
    • Realize the growing importance and relevance of international accounting issues to the practice of accounting in the United States and understand the role of the IASB in international accounting standard setting.
    • Understand the significance of the FASB’s conceptual framework in outlining the qualities of good accounting information, defining terms such as asset and revenue, and providing guidance about appropriate recognition, measurement, and reporting.
    • Identify career opportunities related to accounting and financial reporting and understand the importance of personal ethics in the practice of accounting.
  • 4. 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 , p. 8)
  • 5. Key Features
    • Provides a vital service in today’s business environment.
    • Uses quantitative financial information in conjunction with qualitative evaluations to help make decisions.
    • Helps in decision making for scarce resources.
    • Impacts economic decisions about the future by analyzing past information.
  • 6. 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 company.
    • External users make decisions concerning their relationship to the enterprise.
  • 7. Users of Financial Information Investors Community Board of Directors Management Employees Suppliers Employees Creditors Customers Analysts Government Internal Users External Users
  • 8. Branches of Accounting
    • Management accounting deals with financial reporting for internal users- especially management.
    • Financial accounting focuses on creating and communicating financial information for external users.
  • 9. Financial Reporting 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. The income statement reports, for a specified interval, the net assets generated through business operations (revenues), the net assets consumed (the expenses), and the net income. The statement of cash flows reports, for a specified time period, the amount of cash generated and consumed by a company through operating, financing, and investing activities. Accounting estimates and judgments are outlined in the notes to financial statements.
  • 10. Stop & Think
    • In addition to the financial statements, the management of a company has a variety of other methods of communicating financial information to external users. Which ONE of the following is NOT one of those methods?
  • 11. 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.
  • 12. Types of Audit Opinions
    • Unqualified opinion - the financial statements are presented in accordance with GAAP.
    • Qualified opinion- except for the effects of the qualified item, the financial statements are presented in conformity with GAAP.
    • No opinion – no opinion is expressed about the financial statements.
    • Adverse opinion- the financial statements do not present information in conformity with GAAP.
  • 13. Accounting Standards Setting Organizations IAPC GASAC FASAC FASB FAF SEC AcSEC AICPA IASC Other EITF GASB U.S. Gov't
  • 14. Securities Exchange Commission (SEC)
    • 1929 stock market crash blamed on nonstandard accounting.
    • 1933 Securities Act established SEC to standardize accounting.
    • Created to protect the interests of investors by ensuring full and fair disclosure.
    • Granted legal authority to dictate GAAP.
    • Has tended to defer setting GAAP to the accounting profession.
  • 15. Securities Exchange Commission (SEC)
    • Financial Reporting Releases – official statements which are accounting interpretations and policies the SEC uses in evaluating firms’ disclosure policies.
    • Other Authoritative Literature:
      • Staff Accounting Bulletins
      • Accounting and Auditing Enforcement Releases
      • Accounting Series Releases
  • 16. Accounting Standards Setting Organizations IAPC GASAC FASAC FASB FAF SEC AcSEC AICPA IASC Other EITF GASB U.S. Gov't
  • 17. Financial Accounting Standards Board (FASB)
    • A private sector body responsible for the US accounting standards (also known as GAAP).
    • Seven full-time members comprise this independent body.
    • Issues Statements of Financial Accounting Standards .
    • Determines GAAP by “due process.”
    • Works within the Conceptual Framework.
  • 18. FASB “Due Process”
    • Topic or project added to agenda.
    • Task force assembled to study topic.
    • Research and analysis performed by FASB technical staff.
    • Discussion Memorandum (DM) drafted and released.
    • Public hearing, usually 60 days later, is held.
    • Board analyzes and evaluates public response.
  • 19. FASB “Due Process” (cont.)
    • Exposure Draft (ED) prepared and released.
    • Sixty-day exposure period allows for public comment.
    • Committee studies public response to exposure draft and prepares final draft.
    • Board votes on final draft leads to either the issuance of a Statement of Financial Accounting Standard , a revised Exposure Draft, or abandonment of the project.
  • 20. Emerging Issue Task Force In an effort to overcome the slow process of standard setting, in 1984 the FASB established the Emerging Issues Task Force (EITF) to assist the FASB in identifying the emerging issues that affect financial reporting.
  • 21. FASB Authority Sources FASB Statement Preparers
    • Financial Executives
    • IMA
    • Individual Corps
    Gov’t Regulators
    • SEC
    • State Boards
    of Public Acct.
    • American Acct.
    Instructors Association Auditors
    • AICPA
    • State societies of
    • Major audit firms
  • 22. FASB Authority Sources- SEC FASB Congress SEC Registrant Companies
  • 23. American Institute of Certified Public Accountants (AICPA)
    • Professional organization of practicing CPAs in the United States
    • Responsibilities include:
      • certification
      • continuing education
      • quality control
      • standard setting
  • 24. Internal Revenue Service
    • The Internal Revenue Service (IRS) has the primary goal of equitable collecting revenue.
    • Although not the same, there are many areas where tax and financial accounting are related.
  • 25. What is GAAP?
    • With so many different bodies creating authoritative literature, what is GAAP?
  • 26. International Accounting Standards Board (IASB)
    • Formed in 1973 to harmonize conflicting worldwide standards.
    • Similar to FASB, IASB develops pronouncements after feedback sessions.
    • Board members are representatives from the US, UK, France, Germany, Sweden, Canada, Australia, South Africa and Japan.
    • IASB standards are called International Financial Reporting Standards (IFRSs).
  • 27. Stop & Think
    • Consider these four organizations:
    • FASB, AICPA, SEC, and IASB.
    • Which one do you think will be making U.S. GAAP 20 years from now?
  • 28. Conceptual Framework
    • Concepts guide the field in developing new accounting policies for a changing business world.
    • When accountants face issues not covered by GAAP, they are to look to the conceptual framework as a guide.
    • This framework can be traced to early AAA publications in 1936.
  • 29. Concepts Statements
    • In 2000, FASB issued Statements of Financial Accounting Concepts which addressed four major areas:
      • Objectives: What are the purposes of financial reporting?
      • Qualitative characteristics: What are the qualities of useful financial information?
      • Elements: What is an asset? A liability? A revenue? An expense?
      • Recognition, measurement, and reporting: How should the objectives, qualities and elements definitions be implemented?
  • 30. Conceptual Framework of Accounting Objectives of Financial Reporting Qualitative Characteristics of Information Accounting Elements of Financial Statements Recognition and Measurement Concepts Assumptions Constraints Principles
  • 31. Objectives of Financial Reporting
    • Usefulness.
    • Understandability.
    • Target audience: investors and creditors.
    • Assessing future cash flows.
    • Evaluating economic resources.
    • Primary focus on earnings.
  • 32. Objectives of Financial Reporting 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.
  • 33. Objectives of Financial Reporting 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.
  • 34. Objectives of Financial Reporting Target Audience While there are many potential users of financial reports, the objectives are directed primarily toward investors and creditors.
  • 35. Objectives of Financial Reporting Assessing Future Cash Flows Financial reporting should provide information that is useful in assessing amounts, timing, and uncertainty (risk) of prospective cash flows .
  • 36. Objectives of Financial Reporting Evaluating Economic Resources Financial reporting should also provide information about an enterprise’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.
  • 37. Objectives of Financial Reporting Primary Focus on Earnings Information about enterprise earnings, measured by accrual accounting, generally provides a better basis for forecasting future performance than does information about current cash receipts and disbursements.
  • 38. Qualitative Characteristics of Accounting Information
    • Benefits greater than cost
    • Relevance
    • Reliability
    • Comparability
    • Materiality
  • 39. Qualitative Characteristics of Accounting Information
  • 40. Qualitative Characteristics of Accounting Information Benefits Greater Than Costs The information must be worth the time and research required to gather and interpret the information.
  • 41. Qualitative Characteristics of Accounting Information Relevance
    • The information must “make a difference”. It must carry the qualities of:
    • Feedback value
    • Predictive value
    • Timeliness.
  • 42. Qualitative Characteristics of Accounting Information Reliability
    • The information must be relatively free from error and represent what it claims to represent. It must have:
    • Verifiability
    • Representational faithfulness
    • Neutrality.
  • 43. Qualitative Characteristics of Accounting Information Comparability The information must be relatable to a benchmark or standard. Similar events must be accounted for in the same manner on the financial statements for different companies and for different periods.
  • 44. Qualitative Characteristics of Accounting Information Materiality Is the item large enough to influence the decision of a user of information? This can never be summarized to a simple numerical benchmark so the accountant must make a judgment based on the company or industry data.
  • 45. Qualitative Characteristics of Accounting Information Conservatism The concept of conservatism can be summarized as follows: When in doubt, recognize all losses but don’t recognize any gains.
  • 46. Elements of Financial Statements
  • 47. Recognition
    • 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.
  • 48. Measurement
    • Five attributes of measurement:
    • Historical cost
    • Current replacement cost
    • Current market value
    • Net realizable value
    • Present (or discounted) value
  • 49. Reporting
    • To meet the objectives of financial reporting, a full set of financial statements should include:
    • 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 for the period
  • 50. Traditional Assumptions
    • Underlying assumptions not addressed in the framework:
    • Economic entity
    • Going concern
    • Arm’s-length transactions
    • Stable monetary unit
    • Accounting period
  • 51. Careers in Financial Accounting
    • Public Accounting
    • Corporate Accounting
    • User (analyst, banker, consultant