Financial Accounting And Accounting Standards

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Environment of Financial Reporting and Factors Affecting it

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Financial Statements and Financial Reporting

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Learning Objective 1:

Identify major Financial Statements and other means of Financial Reporting

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Essential Characteristics of Accounting

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The (1) Identification, measurement and communication of Financial Information about (2) Economic Entities to (3) Interested Parties

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Financial Accounting

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Is the process that culminates in the preparation of financial reports on the enterprise for use by both internal and external parties.

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Users of Financial Accounting

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Include:

1. Investors

2. Creditors

3. Managers

4. Unions

5. Government Agencies

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Managerial Accounting

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Is the process of identifying, measuring, analyzing, and communicating financial information needed by management to plan, control and evaluate a company's operations.

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Financial Statements

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Are the principal means through which a company communicates its financial information to those outside it.

These statements provide a company's history quantified in money terms.

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Types of Financial Statements

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1. Balance Sheet

2. Income Statement

3. Statement of Cash Flows

4. Statement of Owners' or Shareholders' Equity

Note:

Disclosures are an integral part of each Financial Statement.

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Accounting and Capital Allocation

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Learning Objective 2:

Explain how accounting assists in the efficient use of scarce resources

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Capital Allocation Process

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Resources are limited, hence, it must be used effectively and efficiently.

Accountants must measure performance accurately and fairly on a timely basis, so that right managers and companies are able to attract investment capital.

An effective process of capital allocation is critical to a healthy economy. It promotes productivity, encourages innovation and provides an efficient and liquid market for securities whereas unreliable and irrelevant information leads to poor capital allocation and adversely affects the securities market.

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Objective of Financial Reporting

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Learning Objective 3:

Identify the objective of Financial Reporting

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Objective of General Purpose Financial Reporting

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To provide financial information about the reporting entity that is useful to present and potential equity investors, lenders and other creditors in making decisions about providing resources to the entity.

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General-Purpose Financial Statements

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Provide at the least cost, the most useful information possible which aid wide variety of users in making effective decisions.

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Equity Investor and Creditors

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Are identified as the primary users of the general-purpose financial statements. Knowing such helps the company to tailor its financial statements to the needs of these users.

Note:

While the objective of financial reporting is focused on investors and creditors, financial statements may still meet the needs of others.

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Entity Perspective

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Company is viewed as separate and distinct from their owners or shareholders.

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Decision-Usefulness Approach

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Investors are interested in Financial Reporting because it provides information that is useful for making decisions.

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Investors are interested in the following when making decisions:

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1. The company's ability to generate cash inflows

2. Management's ability to protect and enhance the capital providers' investments

Note:

In order for investors to make assessment that is useful for decision making, the following must be understood:

1. The economic resources of an Enterprise

2. The claims to those resources

3. The changes in no. 1 and 2

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The Need to Develop Standards

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Learning Objective 4:

Explain the need for Accounting Standards

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Why is there a need for Accounting Standards?

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The accounting profession has attempted to develop a set of standards that are a) generally accepted and b) universally practiced. Otherwise, each company would have to develop its own standards.

FS readers would have a hard time familirizing every company's peculiar accounting and reporting practices. It would be almost impossible to prepare statements that could be compared.

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Generally Accepted Accounting Principles (GAAP)

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The common set of standards and procedures.

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Generally Accepted

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Means either:

1. that an authoritative accounting rule making body has established a principle of reporting in a given area or

2. that over time a given practice has been accepted as appropriate because of its universal application.

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Parties Involved in Standard Setting

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Learning Objective 5:

Identify the major policy-setting bodies and their role in the standard-setting process.

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Organizations that are instrumental inbthe development of financial accounting standards (GAAP) in US:

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1. Securities and Exchange Commissions (SEC)

2. American Institute of Certified Public Accountants (AICPA)

3. Financial Accounting Standards Board (FASB)

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Securities and Exchange Commissions (SEC)

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Established by the fedefal government (as a result of the 1929 Great Depression) to help develop and standardize financial information presented to stockholders.

SEC is a federal agency which administers the Securities Exchange Act of 1934 and several other Acts.

Most (over 12,000) companies that issue securities to the public or are listed on a stock exchange (NYSE, Nasdaq) are required to file audited financial statements with SEC.

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International Perspective

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The International Organization of Securities Commissions (IOSCO), est in 1987, consist of more than 100 securities regulatory agencies or securities exchanges from all over the world. Collectively, its members represent a substantial proportion of the worlds capital markets. The SEC is a member of IOSCO.

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Public or Private Partnership

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Accounting standards have been developed in the private sector through AICPA or FASB due to the encouragement of SEC.

The SEC has affirmed its support for the FASB by indicating that ginancial statements conforming to standards set by FASB are presumed to have substantial authoritative support. Net, SEC requires registrants to adhere to GAAP.

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SEC Oversight

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The SEC's mandate is to establish accounting principles.

The SEC relies on FASB to develop accounting standards.

The SEC's involvement in the development of accounting standards varies. In some cases, they reject a standard proposed by the private sector. In other cases, the SEC prods the private sector into taking quicker action on certain reporting problems. In still other situations, the SEC communicates problem to FASB, responds to FASB exposure drafts and provides FASB with counsel and advice upon request.

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Enforcement

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Companies listed on Stock Exchange must submit their FS to the SEC.

The SEC process, private sector initiatives, and civil and criminal litigation help to ensure integrity of the financial reporting for public companies.

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American Institute of Certified Public Accountants (AICPA)

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Is the national professional organization of the practicing CPAs. It has been an important contributor to the development of GAAP.

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Committees and Boards that have contributed to the development of GAAP (since the founding of AICPA)

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1. Committee on Accounting Procedure (CAP)

2. Accounting Principle Boards (APB)

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Committee on Accounting Procedure (CAP)

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Was appointed by the AICPA in 1939 due to SEC's urging.

Composed of practicing CPAs.

Issued 51 Accounting Research Bulletin that dealt with various accounting problems from 1939 to 1959. This problem by problem approach failed to provide the needed structured body of accounting principles. Hence, in 1959, Accounting Principles Board (APB) was created by AICPA as a response.

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Accounting Principles Board (APB)

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Major purpose is to 1) advance the written expression of accounting principle, 2) determine appropriate practices and 3) narrow the areas of difference and inconsistency in practice.

It has 18 to 21 members selected primarily from public accounting, including representatives from the industry and academia.

The boards official pronouncement is called APB Opinions. It is intended to be based mainly on research studies and be supported with reasons and analysis.

Between its inception from 1959 to its dissolution in 1973, the APB issued 31 opinions.

Due to lack of productivity and failure to act promptly to correct alleged accounting abuses, it came under fire early.

Wheat Committee (founded by Francis Wheat) was established in 1971 to examine the organization and operation of APB. This led to the replacement of APB with Financial Accounting Standards Board.

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Accounting Principles Boards' Mission to achieve its Objectives or Purpose

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1. To develop an overall conceptual framework to assist in the resolution of problems as they become evident and

2. Substantively research on individual issues before the AICPA issued pronouncements.

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Changing Role of the AICPA

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When FASB replaced APB, the AICPA established the Accounting Standards Executive Committee (AcSEC) as the committee authorized to speak for AICPA in the area of Financial Accounting and Reporting.

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AcSEC speaks through the following various written communucations:

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Audit and Accounting Guides

Summarize the accounting practices of specific industries and provides specific guidance on matters not addresed.

Examples are accounting for casinos, airlines, colleges and universities, banks, insurance companies, etc.

Statement of Position

Provides guidance on financial reporting topics until the FASB sets standards on the issues on question.

SOPs may update, revise, and clarify audit and accounting guides or provide free-standing guidance.

Practice Bulletins

Indicate the AcSEC's views on narrow financial reporting issues not considered by the FASB.

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Note on AICPAs Changing Role

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The role of the AICPA in standard-setting has diminished. The FASB and the AICPA agree that the AlCPA and AcSEC no longer will issue authoritative accounting guidance for public companies.

Furthermore, while the AICPA has been the leader in developing auditing standards through its Auditing Standards Board, the Sarbanes-Oxley Act of 2002 requires the Public Company Accounting Oversight Board to oversee the development of auditing standards.

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Financial Accounting Standards Board (FASB)

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The Wheat Committee's recommendations resulted in the creation of a new standardsetting structure composed of three organizations:

Financial Accounting Foundation (FAF)

The Financial Accounting Foundation selects the members of the FASB and the Advisory Council, funds their activities, and generally oversees the FASB’s activities.

Financial Accounting Standards Board (FASB)

The major operating organization in this three-part structure is the Financial Accounting Standards Board (FASB).

Its mission is 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.

The expectations of success and support for the new FASB relied on several significant differences between it and its predecessor, the APB:

1. Smaller membership. The FASB consists of seven members, replacing the relatively large 18-member APB. 2. Full-time, remunerated membership. FASB members are well-paid, full-time members appointed for renewable 5-year terms. The APB members volunteered their part-time work. 3. Greater autonomy. The APB was a senior committee of the AlCPA. The FASB is not part of any single professional organization. it is appointed by and answerable only to the Financial Accounting Foundation, 4. Increased independence. APB members retained their private positions with firms, companies, or institutions. FASB members must sever all such ties. 5. Broader representation. All APB members were required to be CPAs and members of the AlCPA. Currently, it is not necessary to be a CPA to be a member of the FASB.

Financial Accounting Standards Advisory Council (FASAC)

In addition to research help from its own staff, the FASB relies on the expertise of various task force groups formed for various projects and on the Financial Accounting Standards Advisory Council (FASAC). The FASAC consults with the FASB on major policy and technical issues and also helps select task force members.

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Organizatiobal Structure for Setting Accounting Standards

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Due Process

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In establishing financial accounting standards, the FASB relies on two basic premises.

1. The FASB should be responsive to the needs and viewpoints of the entire economic community, not just the public accounting profession.

2. It should operate in full view of the public through a "due process" system that gives interested persons ample opportunity to make their views known.

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The Due Process System of FASB

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Accounting Standards Update Effectivity

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The passage of new FASB guidance or pronouncement in the form of an Accounting Standards Update (ASU) requires the support of four out of the seven Board members.

FASB pronouncements are considered GAAP and thereby binding in practice.

All ARBs and APB Opinions implemented by 1973 (when the FASB formed) continue to be effective until amended or superseded by FASB pronouncements.

In recognition of possible misconceptions of the term ”principles,” the FASB uses the term financial accounting standards in its pronouncements.

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Types of Pronouncements

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1. Accounting Standards Updates

2. Financial Accounting Concepts

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Accounting Standards Updates

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The FASB issues accounting pronouncements through Accounting Standards Updates (Updates).

These Updates amend the Accounting Standards Codification, which represents the source of authoritative accounting standards, other than standards issued by the SEC. Each Update explains how the Codification has been amended and also includes information to help the reader understand the changes and when those changes will be effective.

Common forms of amendments are accounting standards issued that address a broad area of accounting practice (such as the accounting for leases) or interpretations that modify or extend existing standards.

Prior standardsetters such as the APB also issued interpretations of APB Opinions.

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Emerging Issues Task Force (EITF)

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A second type of Update is a consensus of the Emerging Issues Task Force (EITF), created in 1984 by the FASB.

The EITF is comprised of representatives from CPA firms and financial statement preparers. Observers from the SEC and AlCPA also attend ElTF meetings.

The purpose of the task force is to reach a consensus on how to account for new and unusual financial transactions that may potentially create differing financial reporting practices.

Examples include accounting for pension plan terminations, revenue from barter transactions by Internet companies, and excessive amounts paid to takeover specialists. The ElTF also provided timely guidance for the accounting for loans and investments in the wake of the credit crisis.

The EITF helps the FASB in many ways. The ElTF identifies controversial accounting problems as they arise. The EITF determines whether it can quickly resolve them or whether to involve the FASB in solving them.

In essence, it becomes a ”problem filter" for the FASB. Thus, the FASB will hopefully work on more pervasive long-term problems, while the EITF deals with short-term emerging issues.

We cannot overestimate the importance of the EITF. In one year, for example, the task force examined 61 emerging financial reporting issues and arrived at a consensus on approximately 75 percent of them.

The FASB reviews and approves all ElTF consensuses. And the SEC indicated that it will view consensus solutions as preferred accounting. Further, it requires persuasive justification for departing from them.

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Financial Accounting Concepts

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As part of a long-range effort to move away from the problem-by-problem approach, the FASB in November 1978 issued the first in a series of Statements of financial Accounting Concepts as part of its conceptual framework project.

The series sets forth fundamental objectives and concepts that the Board uses in developing future standards of financial accounting and reporting.

The Board intends to form a cohesive set of interrelated concepts-a conceptual framework-that will serve as tools for solving existing and emerging problems in a consistent manner.

Unlike a Statement of Financial Accounting Standards, a Statement of Financial Accounting Concepts does not establish GAAP. Concepts statements, however, pass through the same due process system (preliminary views, public hearing, exposure draft, etc.) as do standards statements.

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Generally Accepted Accounting Principles (GAAP)

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Learning Objective 6:

Explain the meaning of GAAP and the role of codification for GAAP.

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Generally Accepted Accounting Principles Notes

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Generally accepted accounting principles (GAAP) have substantial authoritative support.

The AlCPA’s Code of Professional Conduct requires that members prepare financial statements in accordance with GAAP. Specifically, Rule 203 of this Code prohibits a member from expressing an unqualified opinion on financial statements that contain a material departure from generally accepted accounting principles.

What is GAAP? The major sources of GAAP come from the organizations discussed earlier in this Chapter. It is composed of a mixture of over 2,000 documents that have been developed over the last 70 years or so. It includes APB Opinions, FASB Standards, and AICPA Research Bulletins. In addition, the FASB has issued interpretations and FASB Staff Positions that modified or extended existing standards. The APB also issued interpretations of APB Opinions. Both types of interpretations are considered authoritative for purposes of determining GAAP.

Since replacing the APB, the FASB has issued over 160 standards, 48 interpretations, and nearly 100 staff positions.

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The Different Types of Documents that Comprise GAAP

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FASB Codification

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Historically, the documents that comprised GAAP varied in format, completeness, and structure, In some cases, these documents were inconsistent and difficult to interpret. As a result, financial statement preparers sometimes were not sure whether they had the right GAAP. Determining what was authoritative and what was not became difficult.

In response to these concerns, the FASB developed the Financial Accounting Standards Board Accounting Standards Codification (or more Simply, ”the Codification").

The FASB’s primary goal in developing the Codification is to provide in one place all the authoritative literature related to a particular topic. This will simplify user access to all authoritative U.S. generally accepted accounting principles.

The Codification changes the way GAAP is documented, presented, and updated. It explains what GAAP is and eliminates nonessential information such as redundant document summaries, basis for conclusions sections, and historical content.

In short, the Codification integrates and synthesizes existing GAAP; it does not create new GAAP. It creates one level of CAAP, which is considered authoritative. All other accounting literature is considered nonauthoritative.

To provide easy access to this Codification, the FASB also developed the Financial Accounting Standards Board Codification Research System (CRS). CRS is an online, real-time database that provides easy access to the Codification. The Codification and the related CRS provide a topically organized structure, subdivided into topic, subtopics, sections, and paragraphs, using a numerical index system.

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Issues in Financial Reporting

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Learning Objective 7:

Describe the impact of user-group in the rule making process.

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GAAP in a Political Environment

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User groups are possibly the most powerful force influencing the development of GAAP. User groups consist of those most interested in or affected by accounting rules. Like lobbyists in our state and national capitals, user groups play a significant role. GAAP is as much a product of political action as it is of careful logic or empirical findings.

User groups may want particular economic events accounted for or reported in a particular way, and they fight hard to get what they want. They know that the most effective way to influence GAAP is to participate in the formulation of these rules or to try to influence or persuade the formulator of them.

These user groups often target the FASB, to pressure it to influence changes in the existing rules and the development of new ones. In fact, these pressures have been multiplying. Some influential groups demand that the accounting profession act more quickly and decisively to solve its problems. Other groups resist such action, preferring to implement change more slowly, if at all.

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User-Groups that Influence the Formulation of Accounting Standards

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International Perspective

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Foreign accounting firms that provide an audit report for a U.S.-listed company are subject to the authority of the accounting oversight board (mandated by the Sarbanes-Oxley Act).

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The Expectations Gap

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The Sarbanes-Oxley Act was passed in response to a string of accounting scandals at companies like Enron, Cendant, Sunbeam, Rite-Aid, Xerox, and WorldComV This law increased the resources for the SEC to combat fraud and curb poor reporting practices. And the SEC has increased its policing efforts, approving new auditor independence rules and materiality guidelines for financial reporting. In addition, the SarbanesOxley Act introduces sweeping changes to the institutional structure of the accounting profession.

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The following are some of the key provisrons of the legislation.

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1. Establishes an oversight board, the Public Company Accounting Oversight Board (PCAOBI, for accounting practices. The PCAOB has oversight and enforcement authority and establishes auditing, quality control, and independence standards and rules.

2. Implements stronger independence rules For auditors. Audit partners, for example, are required to rotate every five years, and auditors are prohibited from offering certain types of consulting services to corporate clients.

3. Requires C E05 and CF05 to personally certify that financial statements and disclosures are accurate and complete, and requires CEOs and CF05 to forfeit bonuses and profits when there is an accounting restatement.

4. Requires audit committees to be comprised of independent members and members with financial expertise.

5. Requires codes of ethics for senior financial officers.

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Section 404 of the Sarbanes-Oxley Act

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In addition, Section 404 of the Sarbanes-Oxley Act requires public companies to attest to the effectiveness of their internal controls over financial reporting.

lntemal controls are a system of checks and balances designed to prevent and detect fraud and errors. Most companies have these systems in place, but many have never completely documented them. Companies are finding that it is a costly process but perhaps badly needed. While there continues to be debate about the benefits and costs of SarbanesOxley (especially for smaller companies), studies at the time of the act's implementation provide compelling evidence that there was much room for improvement. Will these changes be enough? The expectations gap - what the public thinks accountants should do and what accountants think they can do - is difficult to close.

Due to the number of fraudulent reporting cases, some question whether the profession is doing enough. Although the profession can argue rightfully that accounting cannot be responsible for every financial catastrophe, it must continue to strive to meet the needs of society. However, efforts to meet these needs will become more costly to society. The development of a highly transparent, clear, and reliable system will require considerable resources.

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Financial Reporting Challenges

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Learning Objective 8:

Describe some of the challenges facing financial reporting.

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Some of the financial challenges noted:

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While our reporting model has worked well in capturing and organizing financial information in a useful and reliable fashion, much still needs to be done.

1. Nonfinancial measurements. Financial reports failed to provide some key performance measures widely used by management, such as customer satisfaction indexes, backlog information, reject rates on goods purchased, as well as the results of companies' sustainability efforts.

2. Forward-looking information. Financial reports failed to provide forward-looking information needed by present and potential Investors and creditors. One individual noted that financral statements in 2014 should have started with the phrase, "Once upon a time,” to signify their use of historical cost and accumulation of past events.

3. Soft assets. Financial reports focused on hard assets (inventory, plant assets) but failed to provide much information about a company’s soft assets (intangibles). The best assets are often intangible. Consider Microsoft's know-how and market dominance, WaI-Mart's expertise in supply chain management, and Procter & Gamble‘s brand image.

4. Timeliness. Companies only prepared financial statements quarterly and provided audited financials annually. Little to no real-time financial statement information was available.

5. Understandibility. Investors and market regulators were raising concems about the complexity and lack of understandabillty of financial reports. We believe each of these challenges must be met for the accounting profession to provide the type of information needed for an efficient capital allocation process.

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We are confident that changes will occur, based on these positive signs:

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● Already, some companies voluntarily disclose information deemed relevant to investors. Often such information is nonfinancial. For example, banking companies now disclose data on loan growth, credit quality, fee income, operating efficrency, capital management, and management strategy. lncreasrngly, companies are preparing reports on their sustainability efforts by reporting such information as water use and conservation, carbon impacts, and labor practices. In some cases, ”integrated reports” are provrded, which Incorporate sustainability reports into the traditional annual report, leading some to call for standards for sustainability reporting.

● Initially, companies used the Internet to provide limited financial data. Now, most companies publish their annual reports in several formats on the Web. The most innovative companies offer sections of their annual reports in a format that the user can readily manipulate, such as in an electronic spreadsheet format Companies also format their financial reports using eXtcnsible Business Reporting Language (XBRL), which permits quicker and lower-cost access to companies’ financial information.

● More accounting standards now require the recording or disclosmg of fair value information. For example, companies either record investments in stocks and bonds, debt obligations, and derivatives at fair value, or companies show information related to fair values in the notes to the financial statements, The FASB and the IASB have a converged standard on fair value measures, which should enhance the usefulness of fair value measures in financial statements.

● The FASB is now working on projects that address disclosure effectiveness and a reporhng framework for non-public companies. The projects could go a long way toward addressmg complexny and understandablllty of the information in financial statements, allowing for more-effective, less complex, and flexible reporting to meet the needs of investors.

Changes in these directions will enhance the usefulness of financial reporting and provide useful information to financial statements users.

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International Accounting Standards

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Former Secretary of the Treasury, Lawrence Summers, has indicated that the single most important innovation shaping the capital markets was the idea of generally accepted accounting principles. He went on to say that we need something similar internationally.

We believe that the Secretary is right. Relevant and reliable financial information is a necessity for viable capital markets. Unfortunately, companies outside the United States often prepare financtal statements using standards different from US. CAAP (or simply GAAP). As a result, international companies such as Coca-Cola, Microsoft, and IBM have to develop financial information in different ways. Beyond the additional costs these companies incur, users of the financial statements often must understand at least two sets of accounting standards (understanding one set is hard enough). It is not surprising, therefore, that there is a growing demand for one set of high-quality international standards.

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Two sets of rules accepted for international use presently

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1. Generally Accepted Accounting Principles (GAAP)

2. International Financial Reporting Standards (IFRS) - Issued by the London-based International Accounting Standards Board (IASB)

US companies that list overseas are still permitted to use GAAP, and foreign companies listed on US exchanges are permitted to use IFRS. As you will learn, there are many similarities between GAAP and lFRS.

Already over 115 countries use lFRS, and the European Union now requires all listed companies in Europe (over 7,000 companies) to use it. The SEC laid out a madmap by which all US companies might be required to use lFRS by 2015. Most parties recognize that global markets will best be served if only one set of accounting standards is used. For example, the FASB and the IASB formalized their commitment to the convergence of GAAP and lFRS by issuing a memorandum of understanding (often referred to as the Norwalk agreement). The two Boards agreed to use their best efforts to: 1. Make their existing financial reporting standards fully compatible as soon as practicable, and 2. Coordinate their future work programs to ensure that once achieved, compatibility is maintained.

As a result of this agreement, the two Boards identified a number of short term and long-term projects that would lead to convergence. For example, one short-term project was for the FASB to issue a rule that permits a fair value option for financial instruments This rule was issued in 2007, and now the FASB and the [ASB follow the same accounting in this area Conversely, the lASB completed a prolect related to bormwmg costs, which makes IFRS consistent with GAAP Long-term convergence projects relate to such issues as revenue recognition, the conceptual framework, and leases.

Because convergence is such an Important issue, we provide a discussion of international accounting standards at the end of each chapter called lFRS Insights. This feature will help you understand the changes that are taking place in the financial reporting area as we move to one set of intomational standards. In addition, throughout the textbook, we provide International Perspectives in the margins to help you understand the international reporting environment.

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International Perspective

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The adoption of IFRS by US companies would make it easier to compare US and foreign companies, as well as for US companies to raise capital in foreign markets.

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Ethics in the Environment of Financial Accounting

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Learning Objective 9:

Understand issues related to ethics and financial accounting.

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Ethics in the Environment of Financial Accounting Note

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Robert Sack, a noted commentator on the subject of accounting ethics, observed, "Based on my experience, new graduates tend to be idealistic. Thank goodness for that! Still it is very dangerous to think that your armor is all in place and say to yourself, ‘I would have never given into that. The pressures don't explode on us, they build, and we often don't recognize them until they have us."

These observations are particularly appropriate for anyone entering the business world. In accounting, as in other areas of business, we frequently encounter ethical dilemmas. Some of these dilemmas are simple and easy to resolve. However, many are not, requiring difficult choices among allowable alternatives.

Companies that concentrate on "maximizmg the bottom line," ”facing the challenges of competition," and “stressing short-term results" place accountants in an environment of conflict and pressure Basic questions such as, "is this wav of communicating financial information good or bad?" ”Is it right or wrong?" and "What should I do in the circumstance?" cannot always be answered by Simply adhering to GAAP or following the rules of the professmn. Technical competence is not enough when encountering ethical decisions.

Doing the right thing is not always easy or obvious. The pressures ”to bend the rules," "to play the game," or “to iust ignore it" can be considerable. For example, "Will my decision affect my job performance negatively?” ”Will my superiors be upset?" and ”Will my colleagues be unhappy with me?" are often questions business people face in making a tough ethical decision. The decision is more difficult because there is no comprehensive ethical system to provide guidelines.

Time, job, client, personal, and peer pressures can complicate the process of ethical sensmvrty and selection among altematives. Throughout this textbook, we present ethical considerations to help sensitize you to the tvpe of situations you may encounter in the performance of your professional responsibility.

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Conclusion

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Bob Herz, former FASB chairman, believes that there are three fundamental considerations the FASB must keep in mind in its rule-making activities:

(1) improvement in financial reporting.

(2) Simplification of the accounting literature and the rule-making process, and

(3) international convergence.

These are notable objectives, and the Board is making good progress on all three dimensions. Issues such as off-balance-sheet financmg, measurement of fair values, enhanced criteria for revenue recognition, and stock option accounting are examples of where the Board has exerted leadership improvements in financial reporting should follow.

Also, the Board is making it easier to understand what GAAP is. GAAP has been contained in a number of different documents The lack of a single source makes it difficult to access and understand generally accepted principles. As discussed earlier, the Codification now organizes existing GAAP by accounting topic regardless of its source (FASB Statements, APB Opinions, and so on). The codified standards are then considered to be GAAP and to be authoritative. All other literature will be considered nonauthoritative.

Finally, international convergence is underway. Some projects already are completed and differences eliminated Many more are on the drawing board. It appears to be only a matter of time until we will have one set of global accounting standards that will be established by the IASB. The profession has many challenges, but it has responded in a timely, comprehensive, and effective manner.

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SUMMARY OF LEARNING OBJECTIVES

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1. Identify the major financial statements and other means of financial reporting. Companies most frequently prm ide (1) the balance sheet, (2) the income statement, (3) the statement of cash flows, and (4) the statement of owners' or stockholders' equitv. l-inancml reporting other than financial statements mav take various forms Examples include the preSident’s letter and supplementary schedules in the corporate annual report, prospectuses, reports filed With gm ernment agencies, news releases, management's forecasts, and descriptions of a company's social or enuronmental impact.

2. Explain how accounting assists In the efficient use of scarce resources. Accounting prm. ides reliable, relevant, and timelv information to managers, Investors, and creditors lo allow resource allocation to the most effiCient enterprises. Accounting also pI’OVIdES measurements of efftctency (profitability) and financml soundness.

3. Identify the objective of financial reporting. The obiective of generalpurpose financml reporting is to proVide financial information about the reporting entity that is useful to present and potential equitv im estors, lenders, and other creditors in decisions about providing resources to the entity through equity imestments and loans or other toms of credit. information that is dc‘ClSltln-useful to im estors may also be helpful to other users of financial reporting who are not im estors.

4. Explain the need for accounting standards. The accounting profession has attempted to detelop a set of standards that is generally accepted and unnersally practiced. Without this set of standards, each companv would hauto de\ elop its own standards Readers of financml statements would haw to familiarize themseh es With ev ery companv’s peculiar accounting and reporting practiLes. As a result, it would be almost impossible to prepare statements that could be compared.

5. Identify the major policy-setting bodies and their role in the standardsetting process. The Securities and Int/“mgr COIHHUWIOH ( 5 EC ) is a federal agency that has the broad powers to prescribe, in whatei er detail it desires, the accounting standards to be employed by companies that fall Within its jurisdiction The Ammum Instilim' of Certified Public Accountants (AICI’A) issued standards through its Committee on Accounting Procedure and Accounting Principles Board The Financial Accounting Standards Board (FASB) establishes and improves standards of financial accounting and reporting for the guidance and education of the public.

6. Explain the meaning of generally accepted accounting principles (GMP) and the role of the Codification for GAAP. Generally excepted accounting principles (GAAP) are those principles that have substantial authontatne support, such as FASB standards, interpretations, and Staff Positions, APB Opinions and interpretations, AlCl’A Accounting Research Bulletins, and other authoritatne pronouncements. All these documents and others are now classified in one document referred to as the Codification The purpose of the CodlflttHIOn is to Simplifv user access to all authoritatne U S GAAP The Codification changes the way GAAP is documented, presented, and updated.

7. Describe the Impact of user groups on the rule-making process. User groups mav want particular economic events accounted for or reported in a particular way, and they fight hard to get what they want They especmllv target the FA9B to influence changes in exnstmg CAAP and in the de\ elopment of new rules. Because of the accelerated rate of change and the increased compleiutv of our economy, these pressures have been multiplvmg CAAP is as much a product of political action as it is of careful logic or empirical findings The [A58 is working With the FASB toward international convergence of GAAP.

8. Describe some of the challenges facing financial reporting. Financial reports tail to proude (1) some kev performance measures Widely used by management, (2) forward-looking information needed by im estors and creditors, (3) sufficient information on a company’s soft assets (intangibles), (4) real-time fmancral information, and (5) easyrto-comprehend information.

9. Understand issues related to ethics and financial accounting. Financial accountants are called on for moral discemmont and ethical deciston-making, Dcasmns sometimes are difficult because a public consensus has not emerged to formulate a comprehensiie ethical system that pro» ides guidelines in making ethical judgments.