Transcript A Review of the Accounting Cycle

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chapter 1
FINANCIAL
REPORTING
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Learning Objectives
1. Describe the purpose of financial reporting
and identify the primary financial
statements.
2. Explain the function of accounting standards
and describe the role of the FASB in setting
these standards in the United States.
3. Recognize the importance to financial
reporting of the SEC, AICPA, AAA, and
IRS.
Continued
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Learning Objectives
4. See the growing importance and relevance of
international accounting issues to the practice
of accounting in the United States and
understand the role of the ISAC in
international accounting standard setting.
5. 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,
Continued and reporting.
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Learning Objectives
6. Identify career opportunities related to
accounting and financial reporting in the
fields of public accounting, corporate
accounting, financial analysis, banking, and
consulting.
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Definition for 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. 40)
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Definition for Accounting
Key features of this definition:
• Accounting provides a vital service in
today’s business environment.
• Accounting is concerned primarily
with quantitative financial information
that is used in conjunction with
qualitative evaluations in making
judgments.
Continued
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Definition for Accounting
Key features of this definition:
• Accounting information
is
used
in
Economists and
making decisionsenvironmentalists
about how to
allocate scarce
resources.
remind
us constantly that
we live in a world with
limited resources.
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Definition for Accounting
Key features of this definition:
• Although accountants place much
emphasis on reporting what has
already occurred, this past information
is intended to be useful in making
economic decisions about the future.
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Users of Accounting Information
All parties interested in the
financial health of a
company are called
stakeholders.
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Users of Accounting Information
Two major classifications of stakeholders
Internal users, who
make decisions
directly affecting the External users,
internal operations who make decisions
concerning their
of the enterprise.
relationship to the
enterprise.
Major Internal and External
Stakeholder Groups
Government
Analysts
Investors
Community
Board of Directors
Management
Employees
Suppliers
Employees
Customers
Creditors
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Financial Reporting
The balance sheet
reports, asThe
of aincome
certain statement
specified
point in reports,
time, thefor aThe
statement of cash
interval,
assets
resources
of a the net
flows
reports, for a
throughtime period, the
company (thegenerated
assets),specified
business operations
the company’s
amount of cash generated
(revenues),
the
obligations
(the
andnet
consumed by a
consumed
(the through
liabilities),assets
and the
company
expenses),
and the netfinancing, and
equity of the
owners.operating,
income.
investing activities.
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Financial Reporting
Accounting estimates
and judgments are
outlined in the notes to
financial statements.
Financial Statement
Relationships
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Statement of Cash Flows 2005
Cash From Op
Cash From Inv
Cash From Fin
Net Increase
Beg. Cash
End. Cash
Balance Sheet 12/31/04
Cash
Other
Total
$ 80,000
4,550,000
$4,630,000
Liabilities $2,970,000
Stock
900,000
R/E
760,000
Total
$4,630,000
$ 973,000
(1,188,000)
245,000
$ 30,000
80,000
$ 110,000
Balance Sheet 12/31/05
Income Statement
Revenues $12,443,000
Expenses
11,578,400
Net Income $
864,600
Statement of
Retained Earnings
R/E 12/31/04
Net Income
Dividends
R/E 12/31/05
$ 760,000
864,600
(400,000)
$1,224,600
Cash
Other
Total
$ 110,000
4,975,000
$5,085,000
Liabilities $2,860,400
Stock
1,000,000
R/E
1,224,600
Total
$5,085,000
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Auditors
Auditors working
issue an
auditor’s
opinion
independently
of
about
the fairness
a company’s
of the statements
management
and
and
their
internal
adherence
to
accountants
proper
accounting
examine
the
principles.
financial
statements.
Auditor’s Opinion
 Unqualified opinion—In the opinion of the auditor, the
financial statements are presented in accordance with
GAAP.
 Qualified opinion—In the opinion of the auditor,
except for the effects of the qualified item, the financial
statement are presented in conformity with GAAP.
 No opinion—The auditor does not express an opinion
about the financial statements.
 Adverse—In the opinion of the auditor, the financial
statements do not present information in conformity
with GAAP.
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Relative Frequency of
Audit Opinions (2000)
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Companies
Unqualified
5,651
Unqualified With Explanatory Language
1,506
Qualified
4
No opinion
2
Adverse
1
Total
7,164
Accounting Standard–Setting
Organizations
FAF
GASAC
GASB
SEC
FASAC
AICPA
FASB
EITF
AcSEC
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Other
U.S. Gov't
IAPC
IASC
Financial Accounting
Standards Board
Committee on
Accounting
Procedures
(CAP)
Born:
1939
Died:
1959
Pronouncements:
Accounting
Research Bulletins
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Financial Accounting
Standards Board
Accounting
Principles
Board
(APB)
Born:
1959
Died:
1973
Pronouncements:
APB Opinions
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Financial Accounting
Standards Board
Financial
Accounting
Standards Board
(FASB)
Born:
1973
Died:
Pronouncements:
Statements of
Financial Accounting
Standards
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Financial Accounting
Standards Board
1) Seven full-time members comprise
this independent body.
2) Issues Statements of Financial
Accounting Standards.
3) Determines GAAP by “due
process.”
4) Works within the Conceptual
Framework.
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FASB Authority Sources—
Overview
Gov’t Regulators
Instructors
• SEC
• State Boards
of Public Acct.
• American Acct.
Association
FASB
Statement Preparers
• Financial Executives
Institute
• IMA
• Individual Corps
Auditors
• AICPA
• State societies of
CPAs
• Major audit firms
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FASB Authority Sources—SEC
Congress
SEC
FASB
Registrant
Companies
FASB Authority Sources -AICPA
 Provides authority to the FASB through
its Code of Professional Conduct Rule
203.
 AICPA members must show that client
financial statements comply with
FASB pronouncements (GAAP).
 AICPA grants continuing membership
to its members who comply with Rule
203.
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FASB “Due Process”
1) Topic or project added to agenda.
2) Task force assembled to study topic.
3) Research and analysis performed by FASB
technical staff.
4) Discussion Memorandum (DM) drafted
and released.
5) Public hearing, usually 60 days later, is
held.
Continued
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FASB “Due Process”
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6) Board analyzes and evaluates public
response.
7) Exposure Draft (ED) prepared and released.
8) Sixty-day exposure period allows for public
comment.
9) Committee studies public response to
exposure draft and prepares final draft.
Continued
FASB “Due Process”
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10) 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.
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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.
Accounting Standard–Setting
Organizations
FAF
GASAC
GASB
SEC
FASAC
AICPA
FASB
EITF
AcSEC
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Other
U.S. Gov't
IAPC
IASC
Securities Exchange Commission
(1933-present)
 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.
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Securities and Exchange
Commission
SEC official statements are referred to
as Financial Reporting Releases which
are accounting interpretations and
policies the SEC uses in evaluating
firms’ disclosure policies.
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Securities and Exchange
Commission
Other Authoritative Literature
 Staff Accounting Bulletins
 Accounting and Auditing
Enforcement Releases
 Accounting Series Releases
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American Institute of Certified
Public Accountants
The American
Institute of Certified
Public Accountants
(AICPA) is the
professional
organization of
practicing CPAs in the
United States.
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American Accounting Association
What
are
assets ?
The American
Accounting
Association (AAA)
is primarily an
organization for
accounting
professors.
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Internal Revenue Service
The Internal Revenue
Service (IRS) has the
primary goal of
equitable collecting
revenue.
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What is GAAP?
A
B
C
D
Higher Authority
Lower Authority
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What is GAAP?
– FASB Statements
and Interpretations
– APB Opinions
– CAP Accounting
Research Bulletins
Highest Authority
A
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What is GAAP?
– FASB Technical
Bulletins
– AICPA Industry
Audit and
Accounting Guides
– AICPA Statements
of Position
B
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What is GAAP?
– Consensus
Positions of EITF
– AICPA Practice
Bulletins
C
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What is GAAP?
– AICPA Accounting
Interpretations
– FASB “Question and
Answer” guides
– Other widely recognized
industry practices
Lowest Authority
D
International Accounting
Standards Committee
The accounting standards produced
The
Accounting
by
theInternational
International Accounting
Standards
Committeeare
(ISAC)
was
Standards Committee
referred
in 1973 to
develop
to asformed
International
Accounting
worldwide
accounting
standards.
Standards or IAS.
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Conceptual Framework of
Accounting
Objectives
of Financial
Reporting
Qualitative
Characteristics
of Information
Accounting
Elements
of Financial
Statements
Recognition and Measurement Concepts
Assumptions
Principles
Constraints
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Objectives of Financial Reporting
The overall objective of
financial reporting is to
provide information useful
for decision making.
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Objectives of Financial Reporting

Usefulness.

Understandability.

Target audience: investors and creditors.

Assessing future cash flows.

Evaluating economic resources.

Primary focus on earnings.
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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.
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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.
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Objectives of Financial Reporting
Target Audience
While there are many potential users of
financial reports, the objectives are directed
primarily toward investors and creditors.
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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.
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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.
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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.
Qualitative Characteristics of
Accounting Information
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Decision
Makers
Benefits > Cost
Understandability
Decision
Usefulness
Relevance
Predictive
Value
Feedback
Value
Reliability
Timeliness
Verifiability
Representational
Faithfulness
Neutrality
Comparability
(including
Consistency)
Materiality
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What About Conservatism?
The concept of conservatism can be
summarized as follows: When in
doubt, recognize all losses but don’t
recognize any gains.
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Elements of Financial Statements
• Assets
• Liabilities
• Equity, or Net Assets
• Investments by Owners
• Distributions to Owners
• Comprehensive Income
• Revenues
• Expenses
• Gains
• Losses
Recognition, Measurement,
and Reporting
Boiling down all the estimates and
judgments into one
number and then using
that one number to make a
journal entry is called
recognition.
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Recognition, Measurement,
and Reporting
Skipping the journal entry and
just relying on the note to convey
the information to users is called
disclosure.
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Recognition, Measurement,
and Reporting
Measurement
1. Historical cost
2. Current replacement cost
3. Current market value
4. Net realizable value
5. Present (or discounted) value
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Recognition, Measurement,
and Reporting
Reporting




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
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Traditional Assumptions of the
Accounting Model
•
•
•
•
•
Economic entity.
Going concern.
Arm’s-length transactions.
Stable monetary unit.
Accounting period.
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• Public accounting.
• Company
accounting.
• User (analyst,
banker, consultant).