McGraw-Hill/Irwin

Copyright 2011 by the McGraw-Hill Companies, Inc. All rights reserved.

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Environment and Theoretical Structure of Financial Accounting

PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA

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Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Financial Accounting Environment

Providers of Financial Information External User Groups
Investors Creditors Employees Labor unions Customers Suppliers Government agencies Financial intermediaries

Profit-oriented companies Not-for-profit entities Households

Relevant

Financial Information

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Financial Accounting Environment

Relevant financial information is provided primarily through financial statements and related disclosure notes.
Balance Sheet Income Statement Statement of Cash Flows Statement of Shareholders Equity

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The Economic Environment and Financial Reporting

A sole proprietorship is owned by a single individual. A partnership is owned by two or more individuals. A highly-developed system communicates financial information from a corporation to its many shareholders.

A corporation is owned by shareholders.

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Investment-Credit Decisions A Cash Flow Perspective

Shareholders Receive Cash Creditors Receive Cash

1. Dividends 2. Sale of Stock

1. Interest 2. Loan Repayment

Accounting information should help investors and creditors evaluate the amount, timing, and uncertainty of the enterprises future cash flows.
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Historical Perspective and Standards

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Current Standard Setting

Financial Accounting Standards Board
Supported by the Financial Accounting

Foundation Five full-time, independent voting members Answerable only to the Financial Accounting Foundation Members not required to be CPAs
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FASB Accounting Standards Codification

The objective of the codification project was to integrate and organize by topics all relevant accounting pronouncements into a searchable, online database.

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Establishment of Accounting Standards

A Political Process
Internal Revenue Service www.irs.gov American Institute of CPAs www.aicpa.org
GAAP

Financial Executives International www.fei.org

International Accounting Standards Board www.iasb.org Securities and Exchange Commission www.sec.gov
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Governmental Accounting Standards Board www.gasb.org

American Accounting Association www.aaa-edu.org

FASBs Standard-Setting Process

Board receives recommendations for projects. Board votes to add the project to its agenda . Board deliberates the issues at a series of public meetings. Board issues an Exposure Draft (ED). Board holds a public roundtable meeting on the ED. Staff analyzes feedback and the Board re-deliberates the proposed revisions at public meetings . Board issues a Standards Update describing amendments to the Codification.
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Toward Global Accounting Standards

The main objective of the International Accounting Standards Board (IASB) is to develop a single set of high quality, understandable and enforceable global accounting standards to help participants in the worlds capital markets and other users make economic decisions.
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Role of the Auditor

Auditors serve as independent intermediaries to help insure that management has appropriately applied GAAP in preparing the companys financial statements.

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Financial Reporting Reform

As a result of numerous financial scandals, Congress passed the Public Company Accounting Reform and Investor Protection Act of 2002, (Sarbanes-Oxley Act). The goal was to restore credibility and investor confidence in the financial reporting process.

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A Move Away from Rules-Based Standards?

Rules based accounting standards vs.

objectives-oriented approach Objectives oriented (principles-based) approach stressed professional judgment

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Ethics in Accounting
For financial information to be useful, it

should possess the fundamental decisionspecific qualities of relevance and faithful representation. Management may be under pressure to report desired results and ignore or bend existing rules.

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Analytical Model for Ethical Decisions

Determine the facts of the situation. Identify the ethical issue and the stakeholders. Identify the values related to the situation. Specify the alternative courses of action. Evaluate the courses of action. Identify the consequences of each course of action. Make your decision and take any indicated action.

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The Conceptual Framework

The Conceptual Framework has been described as a constitution, a coherent system of interrelated objectives and fundamental that lead to consistent accounting standards.
FASB Conceptual Framework (Statements of Financial Accounting Concepts) Objectives of Financial Reporting (SFAC No. 1) Qualitative Characteristics (SFAC No. 2) Elements of Financial Statements (SFAC No. 6) Recognition and Measurement (SFAC No. 5 and SFAC No. 7)
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The Conceptual Framework

FASB and IASB Joint Conceptual Framework Project
Eight Phases: A. Objective and Qualitative Characteristics B. Elements and Recognition C. Measurement D. Reporting Entity E. Presentation and Disclosure F. Framework for a GAAP Hierarchy G.Applicability to the Not-For-Profit Sector H. Remaining Issues

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The Conceptual Framework

Objective To provide financial information that is useful to capital providers. Fundamental and Enhancing Qualitative Characteristics

Elements

Recognition and Measurement Concepts

Constraints
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Financial Statements

Qualitative Characteristics of Accounting Information

Decision usefulness

Relevance

Faithful representation

Predictive value

Confirmatory value

Completeness Neutrality

Free from material error

Comparability (Consistency)
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Verifiability

Timeliness

Understandability

Practical Boundaries (Constraints) to Achieving Desired Qualitative Characteristics

Cost Effectiveness

Materiality

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Elements of Financial Statements

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Elements of Financial Statements

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Recognition and Measurement Concepts

Recognition
Process of admitting information into the basic financial statements

1. 2. 3. 4.

Definition Measurability Relevance Reliability

Measurement involves both the choice of a unit of measure and the choice of an attribute to be measured.

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Underlying Assumptions and Accounting Principles

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Evolution of Accounting Principles The Asset/Liability Approach

Measure assets and liabilities that exist at a balance sheet date. Recognize revenues, expenses, gains, and losses needed to account for the changes in assets and liabilities from the previous balance sheet date.

The focus on assets and liabilities has led to increased interest on fair value measurement.
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Evolution of Accounting Principles The Move Toward Fair Value

Fair value is the price that would be received to sell assets or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

Market Approaches Cost Approaches

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Income Approaches

Fair Value Hierarchy

GAAP gives companies the option to report some or all of their financial assets and liabilities at fair value.
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End of Chapter 1