Intermediate Acct

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Challenges Facing Financial Accounting

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Non-financial Measurements
Forward-looking Information
Soft Assets
Timeliness

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nonfinancial measurements

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financial reports failed to provide some key performance measures widely used by mangement, such as customer satisfaction indexes, backlog info, and reject rates on goods purchased.

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forward-looking info

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financial reports that use historiacal costs and accumulations of past number

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soft assets

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reports failed to provide info about intangibles(the best assets). know-how and market dominance, unique marketing setups and well trained employees and brand image

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timeliness

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only prepared financial statemetns quarterly, and provided audit financials annualy. Little to no real time financial statements was availible

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Objectives of Financial Accounting.Financial reporting should provide information:

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a)that is useful to present and potential investors and creditors and other users in making rational investment, credit, and similar decisions.
b)to help present and potential investors and creditors and other users in assessing the amounts, timing, and uncertainty of prospective cash receipts.
c)about the economic resources of an enterprise, the claims to those resources, and the effects of transactions, events, and circumstances that change its resources and claims to those resources.

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what is the need to developing accounting standards?

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Various users need financial information such as Balance Sheet,Income Statement
Statement of Stockholders’ Equity,Statement of Cash Flows,Note Disclosure.
The accounting profession has attempted to develop a set of standards that are generally accepted and universally practiced.GAAP

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Parties Involved in Standard Setting

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Securities and Exchange Commission (SEC)
American Institute of Certified Public Accountants (AICPA)
Financial Accounting Standards

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Securities and Exchange Commission

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established by the federal gov't to help develop and standardize financial information presented to stockholders. It is a federal agency. Requires companies that issue securities to the public or are listed on stock exchange to file audited financial statements. Can prescribe in whatever detail it desires, the accounting practices and standards to be employed by companeis within its jurisdiciton. Currently exercises oversight over 12,000 companies that are listed on the major exchanges.

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American Institute of Certified Public Accountants

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the national professional organization of practing CPAs, has been an improtant contributor to GAAP. They established the CAP(Commitee on Accounting Procedure) and APB(Accounting Principles Board)

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Financial Accounting Standards Board

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Mission to establish and improve standards of financial accounting and reporting for the guidance and education of the public, which includes issuers, auditors, and users of financial information.

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Types of Pronouncements Issued by FASB:

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Standards, Interpretations, and Staff Positions.

Financial Accounting Concepts

Emerging Issues Task Force Statements

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Interpretations

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modify or extend existing standards

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staff positions

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provide interpretive guidance and also minor amendments to standards and interpretations.

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Changing role of AICPA

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When FASB replaced tge APB, the AICPA established the Accounting Standards Executive Committee (AcSEC):the commitee authorized to speak for the AICPA in the area of financial accouting and reporting. It does so through various written communication:
Audit and Accounting Guides
Statements of Position (SOP)
Practice Bulletins
AICPA and AcSEC no longer issues authoritative accounting guidance for public companies.
PCAOB oversees the development of auditing standards.
AICPA continues to develop and grade the CPA examination

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Category A (Most Authoritative)
House of GAAP

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FASB Standards, Interpretations, and Staff Positions
APB Opinions
AICPA Accounting Research Bulletins

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Category B

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FASB Technical Bulletins
AICPA Industry Audit and Accounting Guides
AICPA Statements of Position

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Category C

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FASB Emerging Issues Task Force
AICPA AcSEC Practice Bulletins

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Category D (Least Authoritative)

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AICPA Accounting Interpretations
FASB Implementation Guides
Recognized Industry Practices

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Parties involved in standard setting:

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Business Entities

CPAs and
Accounting Firms

AICPA (AcSEC)

Academicians

Investing Public

Financial
Community

Preparers (e.g., FEI)

Government (SEC, IRS, other agencies)

Industry
Associations

All connected to FASB

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SFAC No.1 "Objectives of Financial Reporting by Business Enterprises"

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presents the goals and purposes of accounting

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SFAC No. 2 "Qualitative Characteristics of Accounting Information"

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examines the characteristics that make accounting information useful

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SFAC No.3 "Elements of Financial Statements of Business Enterprises"

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provides definitions of items in financial statements, such as assets, liabilities, revenues, and expenses

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SFAC No. 5 "Recognition and Measurement in Financial Statements of Business Enterprises"

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sets forth fundamental recognition and measurement criteria and guidance on what information should be formally incorporated into financial statements and when

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SFAC No.6 "Elements of Financial Statements"

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replaces No3 and expands its scope to include not for profit organizations

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SFAC No7 "Using Cash Flow INformation and Present Value in Accounting Measurements"

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provides a framework for using expected future cash flows and present values as a basic for measurement

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First Level: Basic Objectives
Financial reporting should provide information that:

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(a) is useful to present and potential investors and creditors and other users in making rational investment, credit, and similar decisions.
(b) helps present and potential investors and creditors and other users in assessing the amounts, timing, and uncertainty of prospective cash receipts.
(c) portrays the economic resources of an enterprise, the claims to those resources, and the effects of transactions, events, and circumstances that change its resources and claims to those resources.

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Second Level: Fundamental Concepts
Qualitative Characteristics

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The FASB identified the Qualitative Characteristics of accounting information that distinguish better (more useful) information from inferior (less useful) information for decision-making purposes

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Understandability

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A company may present highly relevant and reliable information, however it was useless to those who do not understand it.

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Relevance

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Accounting info must be capable of making a difference in a decision.

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For info to be relevant it needs...

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predictive or feedback value, presented on a timely basis

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Reliability

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must be verifiable, have a faithful representation, and be reasonably free of error and bias

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Reliability must be..

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verifiable, represent faithfulness, and be neutral

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Secondary Qualities:

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comparability and consistency

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Comparability

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Information that is measured and reported in a similar manner for different companies is considered comparable

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consistency

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When a company applies the same accounting treatment to similar events from period to period.

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Assets

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probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events

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Liabilities

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Probable future sacrafices of economic benefit arising from present obligations of a paritcular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events

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equity

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residual interest in the assets of an enity that remains after deducting its liabilities. IN a business enterprise, the equity is the ownership interest.

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Investment by owners

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are increases in net assets of a particular enterprise resulting from transfers to it from other parties of something of value to obtain or increase ownership interest (or equity) in it. Assets are most commonly received as investments by owners, but that which is received may also include services or satisfication or conversion of liabilities of the enterprise.

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distribution to owners

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decreases in net assets of a particluar enterprise resulting from transferring assets, rendering services, or incurring liabilites by the enterprise to owners. Distribution to owners decreases ownership interests in an enterprise.

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comprehensive income

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change in equity (net assets) of an enitity during a period from transactions and other events and circumstances from nonowner sources. It includes all changes in equity during a period except those resulting from investments by owners and distribution to owners

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revenues

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inflows or other enhancements of assets of an entity or settlement of its liabilities during a period from delivering or producing goods, rendering services, or other activites that constitute the enitity's ongoing major or central operations

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expenses

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outflows or other using up of assets or incurrences of liabilities during a period from delivering or producing goods, rendering services, or carrying out other activties that constitute the enititys ongoing major or central operations

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gains

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increases in equity from peripheral or incidental transactions of an enitity and from all other transactions and other events and circumstances affecting the entity during a period except those that result from revenues or investments by owners

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losses

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decreases in equity from peripheral or incidental transactions of an entity and from all other transactions and other events and circumstances affecting the entity during a period except those that result from expenses or distribution to owners

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Economic Entity assumption

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company keeps its activity separate from its owners and other businesses.

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Going Concern assumption

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company to last long enough to fulfill objectives and commitments.

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Monetary Unit assumption

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money is the common denominator of economic activity and provides an appropriate basis for accounting measurement and analysis. it is relevant, simple, universially availible, understandable, and useful

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Periodicity assumption

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implies that a company can divide its economic activities into artificial time periods

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measurement principle

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based on historical costs and fair value

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historical cost principle

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generally thought to be reliable, based on the acquistion of price

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fair value principle

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more useful, the price that would be recieved to sell and asset or paid to transfer a liabiblity in an orderly transaction between market participants at the measurement date.Reporting of fair value information is increasing.

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Revenue Recognition

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generally occurs (1) when realized or realizable and (2) when earned.

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a company realizes revenues when..

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it exchanges products, merchandise, or other assets for cash or claims to cash

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revenues are considered earned when..

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the company substantially accomplishes what it must do to be entitled to the benefits represented by the reveneus

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during production

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a company can recognize revenue before it completes the job in long term construction contracts, a company would recognize revenue periodically, based on percentage complete

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at end of production

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recognize after completion of production cycle but before sale takes place, example is mining minerals and some agricultural products

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upon receipt of cash

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periodic installments over long period for retail for farm and home equipment and furnishing

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Matching

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efforts (expenses) should be matched with accomplishment (revenues) whenever it is reasonable and practicable to do so. “Let the expense follow the revenues.”

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Full Disclosure

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providing information that is of sufficient importance to influence the judgment and decisions of an informed user.

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cost-benefit relationship

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the cost of providing the information must be weighed against the benefits that can be derived from using it.

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Materiality

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an item is material if its inclusion or omission would influence or change the judgment of a reasonable person.

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Industry Practice

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the peculiar nature of some industries and business concerns sometimes requires departure from basic accounting theory.

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Conservatism

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when in doubt, choose the solution that will be least likely to overstate assets and income.

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event

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a happening of consequence. An event generally is the source or cause of changes in assets, liabilities, and equity. Events may be external or interal

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transaction

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an external event involving a transfer or exchange between two or more entities

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account

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a systematic arrangement that shows the effect of transactions and other events on a specific element. Companeis keep a seperate account for each asset, liability, revenue, and expense, and for captial. Because the format of an account often resembles the letter T, it is sometimes referred to as T account

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Real Account

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are assets, liabilities, and equity accounts; they appear on the balance sheet

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Nominal Account

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revenue, expense, and dividend accounts; except for dividends, they appear on the income statement. Companies periodically close nominal accounts; they do not close real accounts

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Ledger

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the book containing the accounts. A collection of all the asset, liability, owners equity, revenue, and expense accounts.

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Journal

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the book of original entry where the company initially records transactions and selected other events. Various amounts are transferred from the book of original entry, to the ledger.

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Posting

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the process of transferring the essentiial facts and figures from the book of original entry to the ledger accounts.

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Trial Balance

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the list of all open accounts in the ledger and their balances. Taken immediately after all adjustements have been posted is called adjusted trial balance

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Adjusting Entries

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entires made at the end of an accounting period to bring all acccounts up to date on an accural basis, so that the company can perpare correct financial statements

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financial statements

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statements that reflect the collections, tabulation, and final summarization of the accounting data. Four statements are involved:balance sheet, income statement, statement of cash flows, and statement of retained earnings

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closing entries

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the formal process by which the enterprise reduces all nominal accounts to zero and determines and transfers the net income or net loss to an owners equity account.