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Chapter 1: Accounting: Concepts, Standards and Practice

Chapter 1: Accounting: Concepts, Standards and Practice. Class Case.

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Chapter 1: Accounting: Concepts, Standards and Practice

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  1. Chapter 1: Accounting:Concepts, Standards and Practice

  2. Class Case On 1/1/2005 Dan decided to start his own airport shuttle business. On the same day he bought a used van for $5,500, paid $2,000 for annual registration, taxes and permits and started to drive passengers from & to the airport. By 1/31/2005, Dan serviced over 300 (happy?) passengers and collected a total of $8,000. Some passengers still owe Dan a total of $500 for their trips. Dan paid $4,500 for miscellaneous costs and still owes $1,200 on his credit card for additional expenses. By the end of the month Dan experienced trouble with the van and scheduled to bring it in for repair on 2/1/2005. He expects to pay about $1,000 for the repairs. What was Dan’s gain or loss for the month of January 2005?

  3. Financial Accounting – Big Picture GAAP (Generally Accepted Accounting Principles) The Accounting Information System Financial Statements Parties involved in Standard Setting Conceptual framework

  4. Today’s Class Objectives

  5. Introduction: Financial Statements External financial statements include: • Balance Sheet (also called Statement of Financial Position) • Income Statement • Statement of Stockholders’ Equity (alternatives: Statement of Owners’ Equity) • Statement of Cash Flows

  6. Introduction: Financial Statements Primary external users are: • Current and potential investors • Creditors • Competitors • Regulatory agencies • Employees

  7. Development of GAAP - Generally Accepted Accounting Principles • Accounting standards used today are referred to as Generally Accepted Accounting Principles (GAAP). • These principles are "generally accepted" because an authoritative body has set them or the accounting profession widely accepts them as appropriate.

  8. Development of GAAP: AICPA • AICPA (American Institute of Certified Public Accountants): • Professional organization for public accountants. • Prepares the CPA examination. • AcSEC (Accounting Standards Executive Committee) issues SOPs (Statements of Position), Audit and Accounting Guidelines, Practice Bulletins. • Issues auditing standards (SASs), Attestation Standards, and Quality Control Standards. • Starting 2004, the PCAOB (Public Company Accounting Oversight Board) develops auditing standards for publicly traded companies. • The APB (Accounting Principles Board) issued opinions (Standards) until 1973.

  9. Development of GAAP: FASB • The mission of the Financial Accounting Standards Board(FASB) is to establish and improve standards of financial accounting and reporting for the guidance and education of the public, including issuers, auditors, and users of financial information.

  10. Development of GAAP: FASB • FASB(Financial Accounting Standards Board): • Established in 1973. • Funded by the FAF (Financial Accounting Foundation). • Advised by the FASAC (Financial Accounting Standards Advisory Council). • Independent board (not part of AICPA). • 7 full-time, well-paid, independent board members.

  11. Development of GAAP: FASB • Primary FASB pronouncement is the Statement of Financial Accounting Standard Process for developing a SFAS: Research Discussion Memorandum Hearings Exposure Draft Standard

  12. Development of GAAP: FASB • Other FASB pronouncements: • Interpretations - modify/extend SFASs. • Technical Bulletins - provide guidance. • SFACs (Statements of Financial Accounting Concepts) - not GAAP, but used to develop GAAP. • EITFS (Emerging Issues Task Force Statements)- timely guidance for unusual financial transactions. • Criticism of FASB Standards too costly and complex. Compromises perceived as weakness.

  13. Development of GAAP: SEC • “The primary mission of the U.S. Securities and Exchange Commission (SEC) is to protect investors and maintain the integrity of the securities markets….”

  14. Development of GAAP: SEC • SEC(Securities and Exchange Commission) • Federal agency which administers the Securities Exchange Act of 1934 and several other acts. • has the mandate to establish accounting standards. • Relies on the AICPA and FASB to set accounting standards. • Enforces accounting and disclosure standards. • Chief Accountant of SEC sits on EITF (Emerging Issues Task Force) of the FASB.

  15. PCAOB (Public Company Accounting Oversight Board) • A private-sector, non-profit corporation, created by the Sarbanes-Oxley Act of 2002, to oversee the auditors of public companies in order to protect the interests of investors and further the public interest in the preparation of informative, fair, and independent audit reports. • Has the authority for registration, inspection, and discipline of firms auditing SEC registrants • Sets standards for public company audits

  16. Development of GAAP: Other Influential Organizations • IRS (Internal Revenue Service) • AAA (American Accounting Association) • FEI (Financial Executives Institute) • IMA (Institute of Management Accountants) • FAF (Financial Analysts Federation) • GASB (Governmental Accounting Standards Board) • U. S. Congress

  17. Private Sector (AICPA) Private Sector (FASB) Key Accounting Organizations - US Public Sector (SEC) GAAP

  18. Development of GAAP: International Accounting Standards Committee • The International Accounting Standards Committee (IASC) encourage international cooperation in developing consistent worldwide accounting principles. • In 2001, the IASC was succeeded by the International Accounting Standards Board (IASB).

  19. Development of GAAP: International Accounting Standards Board • The International Accounting Standards Board (IASB) is an independent, privately-funded accounting standard-setter based in London, UK. • The IASB is committed to developing, in the public interest, a single set of high quality, understandable and enforceable global accounting standards that require transparent and comparable information in general purpose financial statements.

  20. Development of GAAP: International Accounting Standards Board • In addition, the IASB co-operates with national accounting standard-setters to achieve convergence in accounting standards around the world. • European Commission presents legislation to require use of IASC Standards for all listed companies no later than 2005.

  21. The House of US GAAP* * Kieso& Weygandt

  22. Today’s Class Objectives

  23. Financial Accounting Concepts - Objectives of Financial Reporting • Provide information useful to business decision-makers. • Provide Information useful in predicting future performance and cash flows of the company. • Provide Information useful to analysts and investors to verify predictions (feedback). • Book: Chapter 1, page 5.

  24. Financial Accounting Concepts - Qualitative Characteristics • Decision Usefulness - contribute to the decision making process. • Relevance: makes a difference in a decision. • Reliability: verifiable, free from bias, representational faithfulness. • relevance and reliability may be in conflict (example: fair value versus historical cost). • Understandability - enables users to perceive the significance of information.

  25. Financial Accounting Concepts - Qualitative Characteristics • Comparability - ability to compare financial information across firms. • Consistency – ability to compare financial information across years for a single firm. • Cost/benefit - the cost of implementing a standard should not exceed the benefits to the users. • Book: Illustration 4, chapter 1, p. 6-8

  26. Financial Accounting Concepts - Basic Assumptions and Principles • Basic assumptions and principles are the foundation of GAAP. They are expressed in the SFACs (Statements of Financial Accounting Concepts) of the FASB. • The concepts do not constitute GAAP, but are used to develop the standards that represent GAAP. • Book: Illustration 5, chapter 1, p. 8-11

  27. Financial Accounting Concepts - Basic Assumptions • Entity Assumption • assets and liabilities of reporting entity are separate from those of the owners. • Going Concern • assumes the entity will not be liquidated in the near future. • Stable Monetary Unit • all monetary units are of equal worth; • Time Period Assumption • information is presented in discrete time periods (years, quarters, months).

  28. Financial Accounting Concepts - Basic Principles • Historical Cost • assets recorded at their historical acquisition price. • Revenue Recognition • revenue is recognized when earnings process substantially complete (generally, when goods and services are delivered). • Matching • expenses incurred to generate revenues should be recorded in the same period. • Full Disclosure • all information needed by decision-makers should be included in the financials or in the notes.

  29. Exceptions (Constraints) to the Basic Assumptions and Principles • These exceptions contradict the basic principles, in certain circumstances. They are: • Materiality(the immateriality constraint) • Only transactions with amounts large enough to make a difference are considered material. • Nonmaterial transactions can be given alternative treatments. • Conservatism - when in doubt: • Understate assets. • Overstate liabilities. • Accelerate recognition of losses. • Delay recognition of gains.

  30. Ex. 1-25 Given the following assumptions, principles and constraints: 1. Comparability 2. Conservatism 3. Consistency 4. Entity 5. Going-concern 6. Historical cost 7. Matching 8. Materiality 9. Stable monetary unit (includes "monetary" recording of transactions in dollars)

  31. Ex. 1-25 7 Match the numbers to the letters below. The information in your text is abbreviated to the right: ____ a. Match expenses of a period to revenues earned during that period. ____ b. Assume that all transactions are recorded in terms of dollars. ____ c. Assumes fluctuations in purchasing power of the dollar are not material. ____ d. Assumes the accountant should focus on transactions that are of significance to users of the financial report. ____ e. When choosing from equal alternatives, choose the one least likely to overstate assets and income. 9 9 8 2

  32. Ex. 1-25 3 ____ f. Once a particular accounting method is adopted, a firm must continue to use that method for other similar transactions. ____ g.Original acquisition cost, not replacement cost, is the basis to be used in most accounting transactions. ____ h. Similar information of different enterprises can be compared, and information from different periods can be compared. ____ i. Distinction is made between a business and its owners. ____ j. Assumption is made that the business will operate indefinitely. 6 1 4 5

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