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Chapter 7

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  • 1. On the topic, “Challenges Facing Financial Accounting,” what did the AICPA Special Committee on Financial Reporting suggest should be included in future financial statements? Non-financial Measurements (customer satisfaction indexes, backlog information, and reject rates on goods purchases). Forward-looking Information Soft Assets (a company’s know-how, market dominance, marketing setup, well-trained employees, and brand image). Timeliness (no real time financial information)
  • Service Cost - Actuaries compute service cost as the present value of the new benefits earned by employees during the year. Future salary levels considered in calculation. Interest on Liability - Interest accrues each year on the PBO just as it does on any discounted debt. Actual Return on Plan Assets - Increase in pension funds from interest, dividends, and realized and unrealized changes in the fair market value of the plan assets. Amortization of Unrecognized Prior Service Cost - The cost of providing retroactive benefits is allocated to pension expense in the future, specifically to the remaining service-years of the affected employees. Gain or Loss - Volatility in pension expense can be caused by sudden and large changes in the market value of plan assets and by changes in the projected benefit obligation. Two items comprise the gain or loss: difference between the actual return and the expected return on plan assets and, amortization of the unrecognized net gain or loss from previous periods
  • Transcript

    • 1.
      • Accounting Principles
      Chapter 7 Financial Accounting, Sixth Edition
    • 2.
      • Explain the meaning of GAAP and identify the key items of the conceptual framework.
      • Describe the basic objectives of financial reporting.
      • Discuss the qualitative characteristics of accounting information and elements of financial statements.
      • Identify the basic assumptions used by accountants.
      • Identify the basic principles of accounting.
      • Identify the two constraints in accounting.
      • Understand and analyze classified financial statements.
      • Explain the accounting principles used in international operations.
      Study Objectives
    • 3. Accounting Principles
      • Monetary unit
      • Economic entity
      • Time period
      • Going concern
      The Conceptual Framework of Accounting Assumptions Principles Constraints in Accounting Statement Presentation and Analysis
      • Objectives of reporting
      • Qualitative characteristics
      • Elements of financial statements
      • Operating guidelines
      • Revenue recognition
      • Matching
      • Full disclosure
      • Cost
      • Materiality
      • Conservatism
      • Summary of conceptual framework
      • Classified balance sheet
      • Classified income statement
      • Analyzing financial statements
      • An international perspective
    • 4. The Conceptual Framework of Accounting Various users need financial information The accounting profession has attempted to develop a set of standards that are generally accepted and universally practiced.
      • Financial Statements
      • Balance Sheet
      • Income Statement
      • Statement of Retained Earnings
      • Statement of Cash Flows
      • Note Disclosure
      Generally Accepted Accounting Principles (GAAP) SO 1 Explain the meaning of GAAP and identify the key items of the conceptual framework.
    • 5. The Conceptual Framework of Accounting
        • Securities and Exchange Commission (SEC)
      http://www.fasb.org/ http://www.sec.gov/ Organizations Involved in Standard Setting:
        • Financial Accounting Standards Board (FASB)
      SO 1 Explain the meaning of GAAP and identify the key items of the conceptual framework.
    • 6. The Conceptual Framework of Accounting
      • Conceptual Framework - “…a constitution, a coherent system of interrelated objectives and fundamentals.”
      • FASB’s conceptual framework consists of the following:
        • Objectives of financial reporting.
        • Qualitative characteristics of accounting information.
        • Elements of financial statements.
        • Operating guidelines (assumptions, principles, and constraints).
      SO 1 Explain the meaning of GAAP and identify the key items of the conceptual framework.
    • 7. Conceptual Framework
      • To provide information that is useful to those making investment and credit decisions.
      • Helpful in assessing future cash flows.
      • Identify the economic resources (assets), the claims to those resources (liabilities), and the changes in those resources and claims.
      Objectives of Financial Reporting SO 2 Describe the basic objectives of financial reporting.
    • 8.
      • According to the FASB conceptual framework, the objectives of financial reporting for business enterprises are based on?
        • Generally accepted accounting principles
        • Reporting on management’s stewardship.
        • The need for conservatism.
        • The needs of the users of the information.
      Conceptual Framework (CPA adapted) Review: SO 2 Describe the basic objectives of financial reporting.
    • 9. Conceptual Framework Question: How does a company choose an acceptable accounting method, the amount and types of information to disclose, and the format in which to present it? SO 3 Discuss the qualitative characteristics of accounting information and elements of financial statements. Answer: By determining which alternative provides the most useful information for decision-making purposes ( decision usefulness ).
    • 10. Conceptual Framework
      • Relevance – making a difference in a decision.
        • Predictive value
        • Feedback value
        • Timeliness
      • Reliability
        • Verifiable
        • Representational faithfulness
        • Neutral - free of error and bias
      Qualitative Characteristics SO 3 Discuss the qualitative characteristics of accounting information and elements of financial statements.
    • 11. Conceptual Framework Comparability – Information that is measured and reported in a similar manner for different companies is considered comparable. Consistency - When a company applies the same accounting treatment to similar events from period to period. Qualitative Characteristics SO 3 Discuss the qualitative characteristics of accounting information and elements of financial statements.
    • 12. Conceptual Framework
        • Revenue
        • Expenses
        • Gains
        • Losses
        • Assets
        • Liabilities
        • Equity
      “ Moment in Time” “ Period of Time” Elements of Financial Statements SO 3 Discuss the qualitative characteristics of accounting information and elements of financial statements.
    • 13. Conceptual Framework Illustration: Identify the element or elements associated with items below.
        • (a) Obligation to transfer resources arising from a past transaction.
        • (b) Items characterized by future economic benefit.
        • (c) Arises from income statement activities that constitute the entity’s ongoing major or central operations.
      Elements (a)
        • Assets
        • Liabilities
        • Equity
        • Revenue
        • Expenses
      (b) (c) (c) SO 3 Discuss the qualitative characteristics of accounting information and elements of financial statements.
    • 14. Conceptual Framework
        • Assets
        • Liabilities
        • Equity
        • Revenue
        • Expenses
        • (d) Residual interest in the net assets of the enterprise.
        • (e) Increases assets through sale of product.
      Elements (a) (b) (c) (c) (d) (e) Illustration: Identify the element or elements associated with items below. SO 3 Discuss the qualitative characteristics of accounting information and elements of financial statements.
    • 15. Conceptual Framework Operating Guidelines
    • 16. Assumptions
      • Assumptions provide a foundation for the accounting process.
        • Monetary Unit
        • Economic Entity
        • Periodicity
        • Going Concern
      SO 4 Identify the basic assumptions used by accountants.
    • 17. Assumptions Only transaction data capable of being expressed in terms of money should be included in the accounting records of the economic entity. SO 4 Identify the basic assumptions used by accountants. Monetary Unit
    • 18. Assumptions Economic events can be identified with a particular unit of accountability. SO 4 Identify the basic assumptions used by accountants. Economic Entity
    • 19. Assumptions SO 4 Identify the basic assumptions used by accountants. Time Period The economic life of a business can be divided into artificial time periods.
    • 20. Assumptions SO 4 Identify the basic assumptions used by accountants. Going Concern The enterprise will continue in operation long enough to carry out its existing objectives.
    • 21. Principles
      • Accounting principles dictate how economic events should be recorded and reported.
        • Revenue Recognition
        • Matching (Expense Recognition)
        • Full Disclosure
        • Cost
      SO 5 Identify the basic principles of accounting.
    • 22. Principles Revenue Recognition - companies should recognize revenue in the accounting period in which it is earned. SO 5 Identify the basic principles of accounting.
    • 23. Principles Matching - efforts (expenses) should be matched with accomplishment (revenues) whenever it is reasonable and practicable to do so. “Let the expense follow the revenues.” Illustration 7-4 Expense Recognition SO 5 Identify the basic principles of accounting.
    • 24. Principles Illustration 7-5 Basic Principles Matching Principle SO 5 Identify the basic principles of accounting.
    • 25. Principles Full Disclosure – Provided through f inancial statements, notes to the financial statements, and supplementary information. SO 5 Identify the basic principles of accounting. Illustration 7-5 Basic Principles
    • 26. Principles Cost Principle – the price, established by the exchange transaction, is the “cost”. SO 5 Identify the basic principles of accounting. Illustration 7-5 Basic Principles
    • 27. Principles Illustration: Identify which basic principle of accounting is best described in each item below. (a) Norfolk Southern Corporation reports revenue in its income statement when it is earned instead of when the cash is collected. (b) Yahoo, Inc. recognizes depreciation expense for a machine over the 2-year period during which that machine helps the company earn revenue. (c) Oracle Corporation reports information about pending lawsuits in the notes to its financial statements. (d) Eastman Kodak Company reports land on its balance sheet at the amount paid to acquire it, even though the estimated fair market value is greater. Revenue Recognition Matching Full Disclosure Cost SO 5 Identify the basic principles of accounting.
    • 28. Constraints in Accounting
      • Constraints permit a company to modify generally accepted accounting principles without reducing the usefulness of the reported information.
        • Materiality
        • Conservatism
      SO 6 Identify the two constraints in accounting.
    • 29. Constraints in Accounting Materiality - an item is material if its inclusion or omission would influence or change the judgment of a reasonable person. Illustration 7-6 Constraints SO 6 Identify the two constraints in accounting.
    • 30. Constraints in Accounting Conservatism - When in doubt, choose the method that will be least likely to overstate assets and income. Illustration 7-6 Constraints SO 6 Identify the two constraints in accounting.
    • 31. Constraints in Accounting Illustration What accounting constraints are illustrated by the items below? (a) Crimson Tide Corporation does not accrue a contingent lawsuit gain of $650,000. (b) Sun Devil Corporation expenses the cost of wastebaskets in the year they are acquired. Conservatism Materiality SO 6 Identify the two constraints in accounting.
    • 32. Summary of Conceptual Framework
    • 33. Statement Presentation and Analysis Classified Balance Sheet SO 7 Understand and analyze classified financial statements. Illustration 7-8 Standard classification
    • 34. Statement Presentation and Analysis Classified Balance Sheet SO 7 Understand and analyze classified financial statements. Illustration 7-9 Proprietorship balance sheet A proprietorship, the balance sheet uses the term “ Owner’s equity” instead of “Stockholders’ equity”
    • 35. Statement Presentation and Analysis Classified Balance Sheet SO 7 Understand and analyze classified financial statements. Illustration 7-10 Partnership balance sheet In a partnership, each partner has a separate capital account.
    • 36. Statement Presentation and Analysis Classified Income Statement SO 7 Understand and analyze classified financial statements.
      • A multiple-step income statement generally includes the following.
        • Sales revenue
        • Cost of goods
        • Operating
        • Other revenues and gains
        • Other expenses and losses
      • Two additional items are income tax expense and earnings per share .
    • 37. Statement Presentation and Analysis Classified Income Statement SO 7 Understand and analyze classified financial statements. Illustration 7-11 Income taxes
    • 38. Classified Income Statement Net Income Earnings Per Share = Number of Common Shares Outstanding Statement Presentation and Analysis Indicates the net income earned by each share of outstanding common stock. SO 7 Understand and analyze classified financial statements.
    • 39. Statement Presentation and Analysis Analyzing Financial Statements SO 7 Understand and analyze classified financial statements.
        • Three major characteristics are generally used:
          • Liquidity ,
          • Profitability , and
          • Solvency .
    • 40. Statement Presentation and Analysis Liquidity SO 7 Understand and analyze classified financial statements. This ratio means that current assets are more than two times greater than current liabilities.
    • 41. Statement Presentation and Analysis SO 7 Understand and analyze classified financial statements. Working capital provides some indication of the company’s ability to meet its existing current obligations. Liquidity
    • 42. Statement Presentation and Analysis SO 7 Understand and analyze classified financial statements. Profitability
    • 43. Statement Presentation and Analysis SO 7 Understand and analyze classified financial statements. Profit Margin Percentage measures the percentage of each dollar of sales that results in net income. Profitability Profitability ratios measure the income or operating success of a company for a given period of time.
    • 44. Statement Presentation and Analysis SO 7 Understand and analyze classified financial statements. Return on Assets is an overall measure of profitability. Profitability Return on Common Equity shows the percentage of net income earned for each dollar of owners’ investment.
    • 45. Statement Presentation and Analysis SO 7 Understand and analyze classified financial statements. Debt to Total Assets measures the percentage of total assets that creditors, as opposed to stockholders, provide. Solvency Solvency measures the ability of an enterprise to survive over a long period of time.
    • 46. Statement Presentation and Analysis SO 8 Explain the accounting principles used in international operations. An International Perspective There are few recognized worldwide accounting standards. The International Accounting Standards Board (IASB), of which the United States is a member, is working to obtain conformity in international accounting practices.
    • 47.
      • Scandals and bankruptcies at Enron, WorldCom, and other companies brought many changes to the way America does business.
      • Many companies have developed a code of ethics to:
        • deter wrongdoing
        • promote honest and ethical conduct
        • indicate that management takes ethics seriously.
      Corporations Have Governance Structures—Do You? All About You
    • 48.
      • Some Facts :
        • Under Sarbanes-Oxley, a company must disclose whether it has a code of ethics.
        • Enron had a code of ethics. Enron’s board of directors knowingly waived requirements of the code so that the CFO could set up and run special purpose entities.
        • In a recent survey of 1,436 workers, 34% said that they have seen unethical activities at their workplace, but only 47% said they are likely to report these activities.
      All About You Corporations Have Governance Structures—Do You?
    • 49. Stockholders often lose money as a result of unethical behavior by management and they often file lawsuits against the company in an effort to recoup these losses. All About You Source: Elaine Buckberg, Todd Foster, and Ronald I. Miller, “Recent Trends in Shareholder Class Action Litigation: Are WorldCom and Enron the New Standard?” NERA Economic Consulting, www.nera.com (accessed June 26, 2006).
    • 50. What Do You Think? Many universities have become concerned about student cheating. Many schools now have student ethics codes. Do you think that these ethics codes serve a useful purpose? All About You YES: Anything that will reduce unethical behavior is a good thing. NO: The existence of an ethics code won’t affect student behavior.
    • 51. Copyright “ Copyright © 2008 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.”

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