Environmental and Theoretical Structure of Financial Accounting

1. Insert Book Cover Picture Environmental and Theoretical Structure of Financial Accounting 1

2. Learning Objectives Describe the function and primaryfocus of financial accounting. LO1

3. 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

4. Financial Accounting Environment 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

5. A highly-developed system of financial reporting is necessary to communicate financial information from a corporation to its many shareholders. The Economic Environment and Financial Reporting A sole proprietorshipis owned by asingle individual. A corporation is ownedby stockholders,frequently numberingin the tens of thousandsin large corporations. A partnership isowned by two ormore individuals.

6. Investment-Credit DecisionsA Cash Flow Perspective Corporate shareholders receive cash from their investments through . . . • Periodic dividend distributions from the corporation. • The ultimate sale of the ownership shares of stock.

7. Investment-Credit DecisionsA Cash Flow Perspective Accounting information should help investors evaluate the amount, timing,and uncertainty of the enterprise’sfuture cash flows.

8. Learning Objectives Explain the difference betweencash and accrual accounting. LO2

9. Cash Versus Accrual Accounting Cash Basis Accounting • Revenue is recognized when cash is received. • Expenses are recognized when cash is paid.

10. Cash Versus Accrual Accounting Accrual Accounting • Revenue is recognized when earned. • Expenses are recognized when incurred.

11. Learning Objectives Define generally accepted accounting principles (GAAP) and discuss the historical development of accounting standards. LO3

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

13. Historical Perspective and Standards Securities and Exchange Commission • 1934 – present Evolution of Standard-Setting Process • 1938 – 1959: • Committee on Accounting Procedures (CAP) • 1959 – 1973: • Accounting Principles Board (APB)

14. Current Standard Setting - FASBwww.fasb.org • Supported by the Financial Accounting Foundation. • Seven full-time, independent voting members serving for 10 years. • Answerable only to the Financial Accounting Foundation. • Members not required to be CPAs.

15. Learning Objectives Explain why the establishment ofaccounting standards is characterizedas a political process. LO4

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

17. FASB’s Standard-Setting Process • Identification of problem. • The task force. • Research and analysis. • Discussion memorandum. • Public response. • Exposure draft. • Public response. • Statement issued.

18. Role of the Auditor Independent intermediary to help insure that management has in fact appropriately applied GAAP.

19. Financial Reporting Reform As a result of numerous financial scandals, Congress passed the Public Company Accounting Reform and Investor Protection Act of 2002, commonly referred to as the Sarbanes-Oxley Act for the two congressmen who sponsored the bill.

20. Learning Objectives Explain the purpose of theFASB’s conceptual framework. LO5

21. The Conceptual Framework • Maintain consistency among standards. • Resolve new accounting problems. • Provide user benefits.

22. Identify the objectives of financial reporting, the qualitative characteristics of accounting information, and the elements of financial statements. LO6 Describe the four basicassumptions underlying GAAP Describe the four basic accountingprinciples that guide accounting practice. LO7 LO8 Learning Objectives

23. The Conceptual Framework Objectives of Financial Reporting (SFAC No. 1) Qualitative Characteristics of Accounting Information (SFAC No. 2) Elements of Financial Statements (SFAC No. 6) Recognition and Measurement Criteria (SFAC No. 5) Environment Implementation Implementation assumptions principles constraints

24. Conceptual Framework • Objectives • To provide information: • Useful for investor and creditor decisions. • That helps predict cash flows. • About economic resources, claims to resources, and changes in resources and claims. Recognition andMeasurementConcepts Elements QualitativeCharacteristics FinancialStatements Constraints Continued

25. Objectives Recognition andMeasurementConcepts AssumptionsEconomic entity Going concern Periodicity Monetary unit Principles Historical cost Realization Matching Full Disclosure Elements Assets Liabilities Equity Investments by Owners Distributions to owners Revenues Expenses Gains Losses Comprehensive Income QualitativeCharacteristics Understandability Primary Relevance Reliability Secondary Comparability Consistency Financial Statements Balance sheet Income statement Statement of cash flows Statement of shareholders’ equity Related disclosures Constraints Cost effectiveness Materiality Conservatism

26. Relevance Reliability PredictiveValue Feedback Value Timeliness Verifiability Neutrality RepresentationalFaithfulness Comparability Consistency Qualitative Characteristics ofAccounting Information Decision Usefulness

27. Practical Constraints to Achieving Desired Qualitative Characteristics Conservatism CostEffectiveness Materiality

28. SFAC No. 6Assets and Liabilities Assets are probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events. Liabilities are probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer or provide services to other entities in the future as a result of past transactions or events.

29. SFAC No. 6Equity Equity, or net assets, called shareholders’ equity or stockholders’ equity for a corporation, is the residual interest in the assets of an entity that remains after deducting liabilities.

30. SFAC No. 6Investments and Distributions Investments by owners are increases in equity resulting from transfers of resources (usually cash) to a company in exchange for ownership interest. Distributions to owners are decreases in equity resulting from transfers to the owners.

31. SFAC No. 6Revenues Revenues are inflows or other enhancements of assets or settlements of liabilities from delivering or producing goods, rendering services, or other activities that constitute the entity’s ongoing major, or central, operations.

32. SFAC No. 6Expenses Expenses are outflows or other using up of assets or incurrences of liabilities during a period from delivering or producing goods, rendering services, or other activities that constitute the entity’s ongoing major, or central, operations.

33. SFAC No. 6Gains and Losses Gains are increases in equity peripheral, or incidental, transactions of an entity. Losses represent decreases in equity arising from peripheral, or incidental, transactions of an entity.

34. SFAC No. 6Comprehensive Income Comprehensive income is the change in equity of a business enterprise 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 from owners and distributions to owners.

35. Recognition and Measurement Concepts

36. Question The function of financial accounting is to identify, measure and communicate financial information about economic entities to interested parties. • a. True • b. False

37. Question The function of financial accounting is to identify, measure and communicate financial information about economic entities to interested parties. • a. True • b. False

38. Question Accrual accounting provides a better indication of ability to generate cash flows than does information limited to the financial effects of cash receipts and cash payments. • a. True • b. False

39. Question Accrual accounting provides a better indication of ability to generate cash flows than does information limited to the financial effects of cash receipts and cash payments. • a. True • b. False

40. Question The primary objective of accrual basis accounting is the measurement of income. • a. True • b. False

41. Question The primary objective of accrual basis accounting is the measurement of income. • a. True • b. False

42. Question Generally accepted accounting principles include both standards set by various rule making bodies and certain accounting practices that have evolved over time. • a. True • b. False

43. Question Generally accepted accounting principles include both standards set by various rule making bodies and certain accounting practices that have evolved over time. • a. True • b. False

44. Question The major financial accounting standard setting body is the • a. Accounting Principles Board • b. Securities and Exchange Commission • c. Financial Accounting Standards Board • d. American Institute of CPAs

45. Question The major financial accounting standard setting body is the • a. Accounting Principles Board • b. Securities and Exchange Commission • c. Financial Accounting Standards Board • d. American Institute of CPAs

46. Question The FASB issues which of the following types of pronouncements? • a. Standards • b. Interpretations • c. Financial Accounting Concepts • d. Technical Bulletins • e. All of the above

47. Question The FASB issues which of the following types of pronouncements? • a. Standards • b. Interpretations • c. Financial Accounting Concepts • d. Technical Bulletins • e. All of the above

48. Question The Financial Accounting Standards Board develops accounting and reporting standards independent of public, business and political pressures. • a. True • b. False

49. Question The Financial Accounting Standards Board develops accounting and reporting standards independent of public, business and political pressures. • a. True • b. False

50. Ethics in Accounting • To be useful, accounting information must be objective and reliable. • Management may be under pressure to report desired results and ignore or bend existing rules.