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Intermediate Accounting, Ninth Edition

Intermediate Accounting, Ninth Edition. Kieso and Weygandt. Prepared by Catherine Katagiri, CPA The College of Saint Rose Albany, New York. John Wiley & Sons, Inc. 1. 1. 1. 1. CHAPTER 1 FINANCIAL ACCOUNTING & ACCOUNTING STANDARDS. After studying this chapter you should be able to:

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Intermediate Accounting, Ninth Edition

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  1. Intermediate Accounting,Ninth Edition Kieso and Weygandt Prepared by Catherine Katagiri, CPA The College of Saint Rose Albany, New York John Wiley & Sons, Inc. 1 1 1 1

  2. CHAPTER 1 FINANCIAL ACCOUNTING &ACCOUNTING STANDARDS After studying this chapter you should be able to: • Describe the essential characteristics of accounting. • Identify the major financial statements and other means of financial reporting. • Explain how accounting assists in the efficient use of scarce resources. • Identify some of the challenges facing accounting. • Identify the objectives of financial reporting. • Explain the need for accounting standards. • Identify the major policy-setting bodies and their role in the standard-setting process. • Explain the meaning of generally accepted accounting principles. • Describe the impact of user groups on the standard-setting process. • Understand issues related to ethics and financial accounting. 2 2 2 2

  3. Accounting: Service Enterprise • The identification, measurement, and communication of financial information about economic entities to interested parties. • Accountants serve as “preparers” to external and internal users. 3 3 3 3

  4. Accounting: Service Enterprise` • Financial Accounting- Intermediate Accounting I & II • Primary perspective is to inform external users of financial information. • Preparation of the financial statements. • Conformance to generally accepted accounting principles (GAAP). • Follows accrual based accounting. 4

  5. Accounting: Service Enterprise • Environmental factors impacting accounting: • Social --The general type of social structure will affect perceived needs, acceptable goals, methods and so on. • Economic --Economic structure will affect how resources are reported on and how resources flow. • Legal --In many ways laws and regulations will affect acceptable accounting theory. • Political --Accounting does not operate in a vacuum and will be influenced by the political environment. • Religious --Accounting will be affected by the basic values of society and individuals which will help determine the allocation of resources. 5

  6. Accounting: Service Enterprise • As a discipline accounting tends to be reactive not proactive. • Generally, since accounting can not experiment with individual firms or the economy as a whole, problems are addressed as they develop rather than anticipating them. • With the increased emphasis on research and early analysis of possible areas of concern, problems can be addressed in a more timely manner. 6

  7. Accounting: Service Enterprise • Accounting: • Follows the separate entity concept. It is assumed the business is separate and distinct from its owners. • Has a standard unit of measure. Transactions will be measured in stable dollars. • Has become increasingly important with the separation of ownership and control in a corporation. There needs to be an independent, reliable means of reporting to the owners since they are not usually involved in the normal operations of the large corporation. 7

  8. Challenges Facing Accounting • Present state of the United States economy is strong due, in part, to the high quality of accounting information and timely reporting. • Challenges facing Accounting: • Non-financial Measurement: To adequately assess performance, liquidity and stability, other non-financial forms of information will need to be available. • Forward-looking information: Accounting relies on, as more reliable, past events (historical costs) rather than expected or projected values or events. Some consideration of tomorrow will have to be considered to enhance the usefulness of accounting information. 8

  9. Challenges Facing Accounting • Soft-assets: Assets besides “hard” property, plant and equipment groupings will need to be considered farther. Human resource accounting, valuing a trained, dedicated work force, the entrepreneurial spirit, are not presently valued on the financial statements today. • Timeliness: Financial statements have been prepared only quarterly, and audited fianancials provided only annually. Little or no real-time financial statement information has been available. 9

  10. Accounting: Service Enterprise • Objectives of Financial Accounting: • Information (disclosure) to a “reasonable person” through the use of accrual accounting. • To aid in investment, credit decisions. • To supply information to help assess the amounts, timing and uncertainty of future cash flows. • To provide information on resources and claims on those resources. • The accrual basis of accounting provides a better analysis tool than a simple analysis of cash receipts and disbursements. More objective. 10

  11. Accounting: Service Enterprise • Development of Standards • To enhance the ability to evaluate information and performance within and between firms, over time. To communicate information that is consistently prepared and comparable. • Standards developed in a very consensual manner. No “ivory tower” approach to rule development. Due process followed (more later). • To help fulfill Accounting’s fiduciary duty to report to public. • To develop a single set of financial statements, ”taken as a whole.” • Income Statement • Balance Sheet • Statement of Retained Earnings • Statement of Cash Flows 11

  12. Accounting: Service Enterprise • Body of rules-GAAP (Generally Accepted Accounting Principles)-uniform theory. “Generally Accepted” means accepted as appropriate by the weight of theory and universality of application. • Historical Perspectives • Industrial Revolution • Before 1900-B/S primary; unsophisticated; Income not reported publicly. • 1913 -Income Tax Act • 1929 -Stock Market Crash • 1933-34 -Securities and Exchange Commission Acts (more later) 12

  13. Parties Involved in Standard Setting • Parties Involved in Standard Setting--AICPA • CAP-Committee on Accounting Procedure 1939-1959 • Part-time, volunteer, appointed. • Issued ARBs (Accounting Research Bulletins) listed on text inside front cover. • Not thorough or involved enough-piecemeal approach. • No basic theory established. 13

  14. Parties Involved in Standard Setting • APB- Accounting Principles Board 1959-1973 Senior Committee of the AICPA. • Issued Opinions, listed on text inside front cover. • Formed to settle problems and do research. • More authority than CAP. • 18-21 members, part-time and poorly paid. Challenged early on from various constituencies. 14

  15. Parties Involved in Standard Setting Wheat Committee formed to address need for coherent approach to theory and practice. Recommended the formulation of: • FASB-Financial Accounting Standards Board (1973-present) • Seven highly paid, full-time members from various constituencies (practice, research, users). 5-year terms. • Independent of AICPA, under the auspices of the Financial Accounting Foundation (FAF). • The FAF selects the members of the FASB. • The FAF oversees the Financial Accounting Standards Advisory Council (FASAC) which has the responsibility to consult with the FASB on major policy and technical issues. 15

  16. Parties Involved in Standard Setting • FASB has broader representation than CAP or APB. • Member need not be a CPA. • FASB issues: • Standards • Interpretations • Concepts • Technical Bulletins • Industry Guides • Please see figure 1-5 House of GAAP (text). 16

  17. Parties Involved in Standard Setting • DUE PROCESS: To develop standards (GAAP) (page 10, text) • A topic or project is identified and placed on FASB’s agenda. • A task force is assembled to define problems, issues and alternatives. • Research is conducted by FASB technical staff. • A discussion memorandum is drafted and released. • Public hearings are held in a timely manner. • The FASB committee analyzes and evaluates public response. • The FASB committee deliberates and prepares and exposure draft. 17

  18. Parties Involved in Standard Setting • Again, public hearings are held in a timely manner, comments taken. • The FASB committee evaluates the public comments and revises the draft as necessary. The full board of FASB reviews final draft and, if approved by a vote of at least 5 of 7, issues a Standards Statement. FASB 18

  19. FASB: A Look to the Future • Public versus Private regulation of profession. The Accounting Profession seeks to govern itself directly rather than have the government directly draw up the GAAP to be followed. • Should Securities and Exchange Commission exercise direct oversight? • Congressional Actions: • Metcalf-Moss-Revised due process procedures. • Dingell Committee (1985)-Standard setting process sufficient. • Trueblood Committee-Set up Accounting Change Commission. 19

  20. FASB: A Look to the Future • Standards Overload v. Timely Guidance • Big GAAP-Complex registrants. • Little GAAP-Nonregistrants, smaller firms. • Very specialized standards--Too complex or complex issues? • Standard overload-A quick look at textbook inner covers for dates demonstrates how numerous and complex new standards have become! • Timely guidance-Due process too long? If faster will issues be adequately addressed? 20

  21. FASB: A Look to the Future • FASB response: • Set up two sets of standards?: OCBOA-Other Comprehensive Basis of Accounting-problems, comparability, consistency. • Increased use of EITF-Emerging Issues Task Force-to prioritize concerns. • Emerging Issues Task Force: • Set up by FAF to advise FASB. • 16 members -no user representation! • Prioritizes issues and treatment: • General consensus there is preferable treatment-no further study. • No consensus but problem narrow-no further action. • No consensus but agreement important--FASB attention. • Is it usurping the FASB’s role? 21

  22. FASB: A Look to the Future • Preparer dominance in setting GAAP (resource allocation)? • Vested interest in simplicity and “work product”. • Reduced SEC involvement lately. • Some wish to change focus of reports from public to management! • Preparers have severely criticized the FASB-not “blue ribbon”. • To prevent abuse Users should remain active! • Greater SEC involvement; preparers lose most by direct regulation. • Careful selection of FASB board members. Members of the FAF selected carefully (independent). 22

  23. Other Important Rulemaking Bodies • SEC-Securities and Exchange Commission • First group to draw up professional standards. • 1933 Act--Set up commission and governed initial issuance of shares. • 1934 Act--Governed subsequent trading in shares. • Statutory power to govern profession-uses “veto power”. • Issues : • FRR (Financial Report Releases) • Regulation S-X which contains instructions and forms for filing financial statements. • Decisions on cases coming before the SEC. 23

  24. Other Important Rulemaking Bodies • Need for regulation arose chiefly out of the corporate characteristic of the separation of ownership and control. Regulation of Securities in the U.S. (federal) • Federal Trade Commission Act (Interstate commerce) • Clayton Act (Interstate commerce) • Early attempts at regulation failed-no “big problem” yet. 24

  25. Other Important Rulemaking Bodies • Regulation of Securities in the U.S. (state) • Kansas 1911-by 1913 22 states had regulatory laws-”blue sky” laws. • Not terribly effective. • Abuses in 1920’s • Price manipulation “wash sales”. • Purchase on “margin”. • Insider trading. • Establishment of the SEC • Charged to ensure “full and fair disclosure”, concern for fraud and securities registration. • Accused of self-interest and accumulating power-- hopefully it serves the public. 25

  26. Other Important Rulemaking Bodies • Growth of SEC • From tentative acceptance SEC has grown and become more involved. • 1962-market disruption brought amendments-Exchange Act. • 1977-Foreign Corrupt Practices Act-Criminal penalties possible for management and accountants; adequacy of internal control. • 1984-Insider Trader Sanctions Act-increased penalties. • Question still remains as to how effective SEC is in regulating capital markets. • Exercises veto power over accounting profession although vested with direct authority (as discussed before). • Regulated filings adequate? 26

  27. Other Important Rulemaking Bodies • Organizational Structure of SEC: • Office of the Chief Accountant is the most powerful in the United States! • Responsible for administration of laws. • Works with the FASB. • Works with many other organizations (e.g., major stock exchanges). • Enforcement by SEC: • Letter of deficiency used if there are questions, irregularities that arise in the financial statements, reports. If the problems persist, a “stop order” will be issued. Criminal charges are possible. 27

  28. Other Important Rulemaking Bodies • GASB-Governmental Accounting Standards Board -1984 • Under the auspices of the FAF. • Operational structure similar to the FASB. • Deals with state and local governmental issues. • Unclear its relationship to FASB-do we need two? 28

  29. Issues in Financial Reporting • Primary Purpose of Financial Accounting: Financial statements that shall not mislead the reader. • GAAP-Rule 203-Code of Professional Conduct--Lends enforceability to GAAP. • “Expectations Gap” This is the difference between what the public expects accountants will be able to do and be responsible for and what the accounting profession is willing and able to assume responsibility for. 29

  30. Issues in Financial Reporting • International Accounting Standards Committee (IASC) • Formed in 1973 to improve standards (as much as possible) in the preparation of the financial statements. • SEC has indicated international companies may use IASC standards in the US if the IASC meets 3 conditions. • The standards constitute a comprehensive, generally accepted basis of accounting • The standards are of high quality and • They be rigorously interpreted and applied. • We will be considering several ethical issues or cases during the course of the semester. Along with other references, please see pages 19 & 20 of your text for the basic steps in the process of enhancing ethical awareness. 30

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