Environment and Theoretical

Structure of Financial Accounting

Chapter 1

Intermediate Financial Accounting

 Financial Accounting
Environment
Providers of
Financial External
Information User Groups

Investors
Profit-oriented Creditors
Relevant Employees
companies
Labor unions
Not-for-profit Customers
entities Financial Suppliers
Information Government
Households agencies
Financial
intermediaries
Intermediate Financial Accounting
 Financial Accounting
Environment
Relevant financial information is provided primarily through
financial statements and related disclosure notes. The following
financial statements are the most frequently provided.
1. Balance Sheet
2. Income Statement
3. Statement of Cash Flows
4. Statement of Shareholders Equity
Starting in 2012, companies must either provide a Statement of
Other Comprehensive Income immediately following the Income
Statement, or present a Combined Statement of Comprehensive
Income that includes the information normally contained in both
the Income Statement and the Statement of Other
Comprehensive Income.
Intermediate Financial Accounting
 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
A corporation is owned
financial information
by shareholders.
from a corporation to
Intermediate Financial Accounting its many
shareholders.
 Investment-Credit Decisions A
Cash Flow Perspective
Shareholders Creditors
Receive Receive
Cash Cash

1. Interest
1. Dividends
2. Repayment of
2. Sale of Stock
Principle

Accounting information should help

investors and creditors evaluate the
amount, timing, and uncertainty of
the enterprises future cash flows.
Intermediate Financial Accounting
 Cash versus Accrual Accounting
Cash Basis Accounting
Revenue is recognized when cash is
received.
O
Expenses are recognized when cash is
R
paid.
O
OR
R
O
R
Accrual Accounting
Revenue is recognized when earned.
Expenses are recognized when incurred.
Intermediate Financial Accounting
 Cash versus Accrual Accounting
Cash Basis Accounting
Carter Company has sales on account totaling
$100,000 per year for three years. Carter
collected $50,000 in the first year and $125,000 in
the second and third years. The company prepaid
$60,000 for three years rent in the first year.
Utilities are $10,000 per year, but in the first year
only $5,000 was paid. Payments to employees
are $50,000 per year.

Lets look at the cash flows.

Intermediate Financial Accounting

 Cash versus Accrual Accounting
Cash Basis Accounting

Intermediate Financial Accounting

 Cash versus Accrual Accounting
Cash Basis Accounting

Cash flows in any one year may not

be a predictor of future cash flows.

Intermediate Financial Accounting

 Cash versus Accrual Accounting

Accrual Basis Accounting

Intermediate Financial Accounting

 Cash versus Accrual Accounting
Accrual Basis Accounting

Net Income is considered a better indicator

of future cash flows.

Intermediate Financial Accounting

 The Development of Financial
Accounting and Reporting Standards

Concepts,
principles, and
procedures
developed to meet the
needs of external
users (GAAP).

Intermediate Financial Accounting

 Historical Perspective and Standards

Intermediate Financial Accounting

 Current U. S. Standard Setting

Financial Accounting
Standards Board

Supported by the Financial Accounting

Foundation
Seven full-time, independent voting
members
Members not required to be CPAs

Intermediate Financial Accounting

 FASB Accounting Standards Codification
The codification project integrates and organizes all
relevant accounting pronouncements into a searchable,
online database.

Intermediate Financial Accounting

 International Standard
Setting

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.
Intermediate Financial Accounting
 Comparison of Organizations of
U.S. and International Standard-
Setters
U.S. GAAP IFRS
International
Regulatory oversight Securities Exchange Organization of
provided by: Commission (SEC) Securities Commissions
(IOSCO)
Foundation providing International Accounting
Financial Accounting
oversight, appointing Standards Committee
Foundation (FAF): 20
members, raising Foundation (IASCF): 22
trustees
funds: trustees
International Accounting
Financial Accounting
Standard-setting Standards Board (IASB):
Standards Board (FASB):
board: 14 members (12 full-
7 full-time members
time; 2 part-time)
Financial Accounting
Advisory council Standards Advisory
Standards Advisory
providing input on Council (SAC): 30-40
Council (FASAC): 30-40
agenda and projects: members
members
International Financial
Emerging Issues Task
Group to deal with Reporting Interpretations
Force (EITF): 15
emerging issues: Committee (IFRIC): 14
members
Intermediate Financial Accounting members
 Efforts to Converge U.S. and
International Standards
Issues and Concerns:
Desire for a single set of global standards
Need for standards that are customized to fit
stringent legal and regulatory requirements of U.S.
Possible differences in implementation and
enforcement
Progress:
September 2002: FASB and IASB sign Norwalk
Agreement.
November 2008: SEC issues a Roadmap with
milestones.
May 2011: SEC issues discussion paper describing a
condorsement approach.
November
Intermediate 2011:
Financial SEC issues two studies comparing
Accounting
U.S. GAAP to IFRS and analyzing how IFRS are
 FASBs Standard-Setting
Process
Board receives recommendations for projects.
FASB Chairman decides whether to add a 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.

Intermediate Financial Accounting

 Role of the Auditor
Auditors serve as independent
intermediaries to help ensure that
management has appropriately
applied U.S. GAAP in preparing the
companys financial statements.

Intermediate Financial Accounting

 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.

Intermediate Financial Accounting

 A Move Away from
Rules-Based Standards?
Rules-based accounting standards
vs.
Objectives-oriented approach

Objectives-oriented
(principles-based)
approach stresses
professional judgment
Intermediate Financial Accounting
 Ethics in Accounting
Code of Ethics:
Provides guidance and rules to help
accounting professionals perform
their professional responsibilities in
an ethical manner.

Intermediate Financial Accounting

 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.

Intermediate Financial Accounting

 The Conceptual Framework
The Conceptual Framework has been described as
an Accounting Constitution. It provides the
underlying foundation for accounting standards.

FASB Conceptual Framework

(Statements of Financial Accounting Concepts)
Objectives of Financial Reporting (SFAC 1, replaced
by SFAC 8)
Qualitative Characteristics (SFAC 2, replaced by
SFAC 8)
Elements
Intermediate of Financial
Financial AccountingStatements (SFAC 3, replaced
by SFAC 6)
 The Conceptual Framework
Objective
To provide financial information
that is useful to capital providers.

Qualitative Recognition and

Characteristics Elements Measurement
Concepts

Financial
Constraints Statements
Intermediate Financial Accounting
 Qualitative Characteristics of
Accounting Information
Decision usefulness

Relevance Faithful representation

Predictive Confirmatory Free from

Materiality Completeness Neutrality
value value error

Comparability
Verifiability Timeliness Understandability
(Consistency)
Intermediate Financial Accounting
 Key Constraint

Cost
Effectiveness

Benefits
Costs

Intermediate Financial Accounting

 Elements of Financial
Statements

Intermediate Financial Accounting

 Elements of Financial
Statements

Intermediate Financial Accounting

 Underlying Assumptions

Intermediate Financial Accounting

 Recognition, Measurement and
Disclosure Concepts
Criteria:
Recognition 1. Definition
Process of admitting information 2. Measurability
3. Relevance
into the basic financial statements
4. Reliability
Measurement
Attributes:
Measurement 1. Historical cost
2. Net realizable
Process of associating value
numerical amounts with the 3. Current cost
elements. 4. Present value of
future cash flows
5. Fair value
Examples:
Disclosure 1. Parenthetical
Process of including amounts
additional
Intermediate supplemental
Financial Accounting 2. Notes to FS

information. 3. Supplemental FS
 Revenue Recognition:
Realization
Two Criteria:
1. Earnings process is complete or virtually
complete.
2. Reasonable certainty as to the
collectability of the asset to be received
(usually cash).

Intermediate Financial Accounting

 Expense Recognition:
Matching
The matching principle requires that all
expenses incurred in generating revenue for a
period also be recognized in the same period.

Four Approaches
1. Based on exact cause-and-effect
relationships.
2. By associating an expense with the revenues
recognized in a specific time period.
3. By a systematic and rational allocation to
specific time periods.
4. In the
Intermediate period
Financial incurred, without regard to
Accounting
related revenues.
 Fair Value Hierarchy

U.S. GAAP gives companies the option to report

some or
Intermediate all of Accounting
Financial their financial assets and liabilities at
fair value.
 Evolving U.S. GAAP
U.S. GAAP has been evolving from an emphasis
on revenues and expenses to an emphasis on
assets and liabilities.
Revenue/Expense Approach: Emphasize
principles for recognizing revenues and expenses,
with some assets and liabilities recognized as
necessary to make the balance sheet reconcile with
the income statement.
Asset/Liability Approach: Emphasize principles
for recognizing assets and liabilities first, and then
recognize and measure the revenues, expenses,
gains, and losses needed to account
for the changes in assets and
liabilities from the previous measurement date.
Intermediate Financial Accounting
 Where Were Headed:
The Conceptual Framework
FASB and IASB Joint Conceptual Framework Project
Eight Phases:
A. Objective and Qualitative Characteristics (Completed)

B. Elements and Recognition (In progress)

C. Measurement (In progress)

D. Reporting Entity (In progress)

E. Presentation and Disclosure

F. Framework for a GAAP Hierarchy

G. Applicability to the Not-For-Profit Sector

H. Remaining Issues

Intermediate Financial Accounting

 End of Chapter 1

Intermediate Financial Accounting