The Environment of Financial Reporting
Chapter 1
COPYRIGHT © 2010 South-Western/Cengage Learning
Intermediate AccountingIntermediate Accounting 11th edition 11th edition
Nikolai Bazley JonesNikolai Bazley Jones
An electronic presentationAn electronic presentationBy Norman SundermanBy Norman Sundermanand Kenneth Buchananand Kenneth BuchananAngelo State University
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1. Understand capital markets and decision making.
2. Know what is included in financial reporting.
3. Explain generally accepted accounting principles (GAAP) and the sources of GAAP.
4. Identify the types of pronouncements issued by the Financial Accounting Standards Board (FASB).
5. Understand how the FASB operates.
Objectives
Objectives
6. Describe the relationship between the Securities and Exchange Commission (SEC) and the FASB.
7. Use ethical models for decision making about ethical dilemmas.
8. Understand creative and critical thinking.
9. Describe the joint convergence project of the FASB and the IASB (Appendix).
10. Understand SEC reporting under U.S. GAAP and IFRS (Appendix).
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More Accountants Needed
New accounting rules pose challenges for financial accounting and projections point to increased
hiring of accounting graduates.
New accounting rules pose challenges for financial accounting and projections point to increased
hiring of accounting graduates.
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Estimated Hiring Increase
Accounting firms of all sizes plan to increase future hiring.
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Capital Markets
Companies need large amounts of capital for operations
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Stock Exchange
Companies may obtain capital by issuing capital stock...
Capital Markets
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Bank
Capital Markets
…or by borrowing from lenders
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Capital Markets
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Accounting Information: Economic Activities and Decision Making
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1. Buy. A potential investor decides to purchase a particular security on the basis of communicated accounting information.
2. Hold. An actual investor decides to retain a particular security on the basis of communicated accounting information.
3. Sell. An actual investor decides to dispose of a particular security on the basis of communicated accounting information.
External and Internal Users
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Sources of AuthoritySources of Authority
Internal needs
Managerial AccountingFinancial Accounting
GAAP
Comparison of Financial and Managerial Accounting
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Time Frame of Reported InformationTime Frame of Reported Information
Present and future
Managerial Accounting
Primarily historical
Financial Accounting
Comparison of Financial and Managerial Accounting
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ScopeScope
Total company
Financial Accounting
Individual departments, divisions, and total company
Managerial Accounting
Comparison of Financial and Managerial Accounting
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Type of InformationType of Information
Primarily quantitative
Sales$275,240
Cost180,120
Gross mar. 95,120
Expenses 80,120
Net inc. $15,000
Financial Accounting
Qualitative as well as quantitative
Materials usage is
unfavorable
by $8,400.
Managerial Accounting
Comparison of Financial and Managerial Accounting
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Statement FormatStatement Format
Prescribed by GAAP; oriented toward investment
and credit decisions
Financial Accounting
Determined by company; focused upon specific decisions being made
Managerial Accounting
Comparison of Financial and Managerial Accounting
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Decision FocusDecision Focus
External
Financial Accounting
Internal
Managerial Accounting
Comparison of Financial and Managerial Accounting
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The company’s accountants prepare both the financial and
the managerial accounting reports…
The company’s accountants prepare both the financial and
the managerial accounting reports…
…and the information comes from the same information system.
…and the information comes from the same information system.
Comparison of Financial and Managerial Accounting
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Financial reporting is the process of communicating
financial accounting information about a company
to external users.
Financial reporting is the process of communicating
financial accounting information about a company
to external users.
Financial Reporting
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1. The balance sheet (or statement of financial position), which summarizes a company’s financial position at a given date.
2. The income statement, which summarizes the results of a company’s income-producing activities for a period of time.
3. The statement of cash flows, which summarizes a company’s cash inflows and outflows for a period of time.
Companies present at least three major financial statements:
Financial Reporting
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A statement of changes in
stockholders’ equity is also included by many
companies.
A statement of changes in
stockholders’ equity is also included by many
companies.
Financial Reporting
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This statement summarizes the changes
in each item of stockholders’ equity for a
period.
This statement summarizes the changes
in each item of stockholders’ equity for a
period.
Financial Reporting
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GAAP are the guidelines, procedures, and practices that a company is required to use in recording and reporting the accounting
information in its audited financial statements.
They are like laws and are the rules that must be followed in financial reporting.
They are like laws and are the rules that must be followed in financial reporting.
Generally Accepted Accounting Principles (GAAP)
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Currently, there is no single document that includes all the accounting standards.
However, the FASB has released its FASB Accounting Standards Codification for verification by its constituents. When
finalized, this Codification will be electronic and will integrate and topically organize U.S.
accounting standards.
FASB Accounting Standards Codification
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A FASB Statements of Financial Accounting Standards and Interpretations, FASB Statement 133 Implementation Issues, FASB Staff Positions, and APB Opinions and CAP (AICPA) Accounting Research Bulletins not superceded by actions of the FASB (as well as SEC releases such as Regulation S-X, Financial Reporting Releases, and Staff Accounting Bulletins for companies that file with the SEC)
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Hierarchy of Sources of GAAP
Categories Authoritative Sources
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B FASB Technical Bulletins, and, if cleared by the FASB, AICPA Industry Audit and Accounting Guides, and AICPA Statements of Position
C FASB Emerging Issues Task Force Consensus Positions, Topics discussed in Appendix D of EITF Abstracts, and, if cleared by the FASB, AICPA Practice Bulletins
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Hierarchy of Sources of GAAP
Categories Authoritative Sources
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Hierarchy of Sources of GAAP
D FASB Q’s and A’s (Implementation Guides), AICPA Accounting Interpretations, AICPA Industry and Audit Guides, and AICPA Statements of Position not cleared by the FASB, and practices that are widely recognized and prevalent either generally or in the industry (e.g., AICPA Accounting Trends and Techniques)
Categories Authoritative Sources
There are electronic databases such as the FASB Financial Accounting Research
System (FARS) that include most accounting standards
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The Codification does not change GAAP. Instead, it reorganizes the many
pronouncements on U.S. GAAP into about 90 accounting topics, organized in a
consistent structure.
FASB Accounting Standards Codification
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The FASB expects the Codification to: Reduce the amount of time and effort needed to
solve an accounting research issue. Improve the usability of the accounting
literature, thereby reducing the chances of not complying with GAAP.
Provide real-time updates as new standards are issued.
FASB Accounting Standards Codification
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The FASB expects to approve the Codification in 2009. At that time, the
Codification will supercede all then-existing non-SEC standards. Once the Codification has been approved, the FASB will not issue separate new pronouncements. Instead, any new standards will be structured in a way to
update the Codification.
FASB Accounting Standards Codification
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History of GAAP in the Private Sector
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Committee on Accounting Procedure (CAP)
In 1938, the AICPA formed the Committee on Accounting Procedure (CAP). This group issued pronouncements known as Accounting Research
Bulletins (ARB), but the CAP did not have authority to enforce its pronouncements and
application was optional. The CAP was criticized because its members were all CPAs and
application was optional, so the AICPA formed the Accounting Principles Board (APB) in 1959 to replace the Committee on Accounting Procedure.
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1. To alleviate criticism about the process of formulating accounting principles, which included wider representation.
2. To create a policy-making body whose rules would be binding on companies rather than optional.
The APB was comprised 17 to 21 The APB was comprised 17 to 21 members, selected primarily members, selected primarily
from the accounting profession.from the accounting profession.
The APB was comprised 17 to 21 The APB was comprised 17 to 21 members, selected primarily members, selected primarily
from the accounting profession.from the accounting profession.
Reasons for Forming the APB
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1. Independence. The members of the APB were part-time volunteers whose major responsibilities were to the business, governmental, or academic organizations employing them.
2. Representation. The public accounting firms and the AICPA were too closely associated with the development of accounting standards.
3. Response time. Emerging problems were not solved quickly enough by the part-time members of the APB.
Criticisms of the APB
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Structure of FASB
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1. Statements of Financial Accounting Standards
2. Interpretations
3. Staff Positions
4. Technical Bulletins
5. Statements of Financial Accounting Concepts
6. Other Pronouncements
Types of Pronouncements Issued by the FASB
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FASB Operating Procedures
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Other Organizations Impacting GAAP
Securities and Exchange Commission (SEC) – The SEC is a governmental agency that has the legal authority to prescribe accounting principles and reporting practices for all corporations issuing publicly traded securities.
American Institute of Certified Public Accountants (AICPA) – The AICPA is the professional organization for all certified public accountants in the United States. To be a member of the AICPA, an individual must have passed the Uniform CPA Examination, hold a CPA certificate, agree to abide by its bylaws and Code of Professional Ethics, and have 150 hours of higher education.
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Other Organizations Impacting GAAP
FASB Emerging Issues Task Force (EITF) – The primary objectives of the EITF are (1) to identify significant emerging accounting issues (i.e., unique transactions and accounting problems) that it feels the FASB should address and (2) to develop consensus positions on the implementation issues involving the application of standards.
International Accounting Standards Board (IASB) – The IASB issues International Financial Reporting Standards (IFRS) and includes 12 full-time members (and 2 part-time members) from various countries. To date IASB has issued 49 Standards.
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Governmental Accounting Standards Board (GASB) – The GASB’s responsibility is to establish financial accounting standards for certain state and local governmental entities.
Public Company Accounting Oversight Board (PCAOB) – The PCAOB is a non-profit corporation that was created by Congress in the Sarbanes-Oxley Act of 2002. Its purpose is to protect the interests of investors by overseeing auditors of public companies in the preparation of informative, accurate, and independent audit reports for companies that sell securities to the public.
Other Organizations Impacting GAAP
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Cost Accounting Standards Board (CASB) – The CASB is responsible only for negotiated federal contracts and subcontracts exceeding $500,000.
Internal Revenue Service (IRS) – The IRS administers the Internal Revenue Code enacted by Congress.
American Accounting Association (AAA) – The AAA is an organization primarily of academics and practicing accountants.
Other Organizations Impacting GAAP
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Financial Executives International (FEI) – The FEI consists primarily of high-level financial executives (such as financial vice-presidents, treasures, and controllers) of major corporations. The FEI publishes a monthly journal called the Financial Executive.
Institute of Management Accountants (IMA) – The primary focus of the IMA is on management accounting and financial accounting issues. The IMA publishes a monthly journal called Strategic Finance.
Other Organizations Impacting GAAP
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CFA Institute (CFAI) – Members of the CFAI are financial analysts who use accounting information in various investment management and security analysis decisions.
Other Organizations Impacting GAAP
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Participants in the Development of GAAP
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ResponsibilitiesResponsibilities
In carrying out their responsibilities as
professionals, members should exercise sensitive professional
and moral judgments in all their activities.
In carrying out their responsibilities as
professionals, members should exercise sensitive professional
and moral judgments in all their activities.
Principles of the AICPA Code of Professional Conduct
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The Public InterestThe Public Interest
Members should accept the obligation to act in a way that will serve the public interest, honor the
public trust, and demonstrate commitment to professionalism.
Members should accept the obligation to act in a way that will serve the public interest, honor the
public trust, and demonstrate commitment to professionalism.
Principles of the AICPA Code of Professional Conduct
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IntegrityIntegrity
To maintain and broaden public confidence, members
should perform all professional responsibilities
with the highest sense of integrity.
To maintain and broaden public confidence, members
should perform all professional responsibilities
with the highest sense of integrity.
Principles of the AICPA Code of Professional Conduct
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Objectivity and IndependenceObjectivity and Independence
A member should maintain objectivity and be free from conflicts of interest in discharging professional responsibilities. A member in public
practice should be independent in fact and appearance.
A member should maintain objectivity and be free from conflicts of interest in discharging professional responsibilities. A member in public
practice should be independent in fact and appearance.
Principles of the AICPA Code of Professional Conduct
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Due CareDue Care
A member should observe the profession’s technical and ethical standards, strive continually to
improve competence and the quality of services, and discharge the
professional responsibility to the best of the member’s ability.
A member should observe the profession’s technical and ethical standards, strive continually to
improve competence and the quality of services, and discharge the
professional responsibility to the best of the member’s ability.
Principles of the AICPA Code of Professional Conduct
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Scope and Nature of ServiceScope and Nature of Service
A member in public practice should observe the Principles of
the CPC in determining the scope and nature of services to
be provided.
A member in public practice should observe the Principles of
the CPC in determining the scope and nature of services to
be provided.
Principles of the AICPA Code of Professional Conduct
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1. The utilitarian model, which evaluates actions based on the “greatest good for the greatest number.”
2. The rights model, which embraces actions that protect individual moral rights.
3. The justice model, which emphasizes a fair distribution of benefits and burdens.
An Ethicist’s Basic Approaches to Moral Reasoning
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Creative and Critical Thinking: Impact on Problem Solving
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IFRS and U.S. GAAP
Many companies have become “globalized”. Currently, U.S. corporations are subject to the accounting standards established by the FASB, while foreign corporations are subject to international financial reporting standards (IFRS) established by the IASB or by accounting standards set by their national accounting standards board. These differences in accounting standards have led to differences among U.S. and foreign corporations’ financial statements. These differences, in turn, have made it difficult for investors and creditors to make valid comparisons across corporations and to make effective buy-sell-hold decisions in the U.S. and foreign capital markets.
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IFRS and U.S. GAAP
To resolve this issue, FASB and the IASB entered into an agreement to develop high-quality, compatible accounting standards that could be used for both “domestic” and “cross-border” financial reporting. To achieve this compatibility, the Boards agreed to work together to achieve “short-term” convergence on a number of individual differences between U.S. and international accounting standards.
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Chapter 1
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