Environment and Theoretical Structure of Financial Accounting

1. 1 Environment and Theoretical Structure of Financial Accounting

2. Relevant Financial Information Financial Accounting Environment Providers of Financial Information External User Groups Profit-oriented companies Not-for-profit entities Households Investors Creditors Employees Labor unions Customers Suppliers Governmentagencies Financialintermediaries

3. 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 Financial Accounting Environment

4. A highly-developed system communicates financial information from a corporation to its many shareholders. The Economic Environment and Financial Reporting A sole proprietorshipis owned by asingle individual. A partnership isowned by two ormore individuals. A corporation is ownedby shareholders.

5. Investment-Credit Decisions ─ A Cash Flow Perspective Shareholders Receive Cash Creditors Receive Cash Dividends Sale of Stock Interest Loan Repayment Accounting information should help investors and creditors evaluate theamount, timing, and uncertainty of the enterprise’s future cash flows.

6. Cash versus Accrual Accounting Cash Basis AccountingRevenue is recognized when cash is received. Expenses are recognized when cash is paid. OROROR OR Accrual Accounting Revenue is recognized when earned.Expenses are recognized whenincurred.

7. 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.Let’s look at the cash flows.

8. Cash versus Accrual Accounting Cash Basis Accounting Cash flows in any one year may notbe a predictor of future cash flows.

9. Cash versus Accrual Accounting Accrual Basis Accounting Net Income is considered a better indicator of future cash flows.

10. The Development of Financial Accounting and Reporting Standards Concepts, principles, and procedures were developed to meet the needs of external users (GAAP).

11. Historical Perspective and Standards

12. 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 Current Standard Setting Financial Accounting Standards Board

13. 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.

14. Establishment of Accounting StandardsA Political Process Internal Revenue Servicewww.irs.gov Financial Executives Internationalwww.fei.org American Institute of CPAswww.aicpa.org GAAP Governmental Accounting Standards Boardwww.gasb.org International Accounting Standards Board www.iasb.org American Accounting Associationwww.aaa-edu.org Securities and Exchange Commissionwww.sec.gov

15. FASB’s 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.

16. 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 world’s capital markets and other users make economic decisions.

17. Role of the Auditor Auditors serve as independent intermediaries to help insure that management has appropriately applied GAAP in preparing the company’s financial statements.

18. 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.

19. A Move Away from Rules-Based Standards? • Rules based accounting standards vs. objectives-oriented approach • Objectives oriented (principles-based) approach stressed professional judgment

20. Ethics in Accounting • For financial information to be useful, it should possess the fundamental decision-specific qualities of relevance and faithful representation. • Management may be under pressure to report desired results and ignore or bend existing rules.

21. Underlying Assumptions and Accounting Principles

22. 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 Income Approaches Cost Approaches

23. Fair Value Hierarchy GAAP gives companies the option to report some or all of their financial assets and liabilities at fair value.