Stice18e PPT Ch01 Student

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Intermediate Accounting

James D. Stice Earl K. Stice

© 2012 Cengage Learning

PowerPoint presented by Douglas Cloud Professor Emeritus of Accounting, Pepperdine University

Financial Reporting

Chapter 1Chapter 1

18th Edition

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Definition of Accounting

“Accounting is a service activity. Its function is to provide quantitative information, primarily financial in nature, about economic entities that is intended to be useful in making economic decisions—in making reasoned choices among alternative courses of action.” Statement of the Accounting Principles Board No. 4, par. 40.

(continued)

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• Accounting information is used in making decisions about how to allocate scarce resources.

• Although accountants place much emphasis on reporting what has already occurred, this past information is intended to be useful in making economic decisions about the future.

Key features in this definition of accounting:

Definition of Accounting

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Users of Accounting Information

• Stakeholders are all parties interested in the financial health of a company.

• Internal users are stakeholders who make decisions that directly affect the internal operations of the enterprise.

• External users are stakeholders who make decisions concerning their relationship to the enterprise.

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1. Management accounting is concerned primarily with financial reporting for internal users, especially management.

2. Financial accounting focuses on the development and communication of financial information for external users.

a. Helps users in determining whether a company’s operations are profitable enough to justify additional funding.

(continued)

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b. Helps users in determining how risky a company’s operations are in order to determine what rate of return is necessary to compensate capital providers for the investment risk.


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Creditors need information about the profitability and stability of the company to decide whether to lend money to the company and, if so, what interest rate to charge.

Creditors need information about the profitability and stability of the company to decide whether to lend money to the company and, if so, what interest rate to charge.

InvestorsInvestors (both (both existing stockholders existing stockholders and potential and potential investors) need investors) need information information concerning the concerning the safety and safety and profitability of their profitability of their investment.investment.

InvestorsInvestors (both (both existing stockholders existing stockholders and potential and potential investors) need investors) need information information concerning the concerning the safety and safety and profitability of their profitability of their investment.investment.

External Investors

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The balance sheet reports, as of a certain point in time, the resources of a company (the assets), the company’s obligations (the liabilities), and the equity of the owners.

(continued)

General-Purpose Financial Statements

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The income statement reports, for a certain interval, the net assets generated through business operations (revenues), the net assets consumed (the expenses), and the difference, which is called net income.

(continued)


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The statement of cash flows reports, for a certain interval, the amount of cash generated and consumed by a company through the following three types of activities: operating, financing, and investing activities.

(continued)


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Accounting estimates and judgments are outlined in the notes to financial statements. In addition, the notes contain supplemental information as well as information about items not included in the financial statements.


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Auditor’s Role

• Auditors, working independently of a company’s management and internal accountants, examine the financial statements.

• They issue an auditor’s opinion about the fairness of the statements and their adherence to proper accounting principles.

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The FASB

• The Financial Accounting Standards Board (FASB) sets accounting standards in the United States.

• The FASB is a private-sector body and has no legal authority.

• The issuance of new accounting standards is preceded by a lengthy public discussion.

(continued)

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• The Emerging Issues Task Force (EITF) works under the direction of the FASB.

• The EITF formulates a timely expert consensus on how to handle new issues not yet covered in FASB pronouncements.

(continued)

The FASB

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• The Securities and Exchange Commission (SEC) was created by the 1933 Securities Act to protect the interests of investors by ensuring full and fair disclosure.

• It was given specific legal authority to establish accounting standards for companies desiring to publicly issue shares in the United States.

(continued)

The FASB

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• The SEC has generally allowed the private-sector organizations to make the accounting standards in the United States (commonly referred to as generally accepted accounting principles (GAAP)).

(continued)

The FASB

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• The Financial Accounting Standards Board (FASB) is currently recognized as the private-sector body responsible for the establishment of U.S. accounting standards.

• The FASB was organized in 1973, replacing the Accounting Principles Board (APB).

• Five full-time members are drawn from a variety of backgrounds—auditing, corporate accounting, financial services, and academia.

(continued)

The FASB

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• Appointment of new Board members is done by the Financial Accounting Foundation (FAF).

• The FAF serves somewhat like a board of directors overseeing the FASB.

• The FAF is also responsible for selecting and supporting members of the Governmental Accounting Standards Board (GASB).

The FASB

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• The major functions of the FASB are to study issues and to establish accounting standards.

• These standards are published as Accounting Standards Updates.

• The FASB has also issued Statements of Financial Accounting Concepts that provide a framework within which specific accounting standards can be developed.

The FASB

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FASB “Due Process”

1. FASB staff assembles background information and the Board holds public meetings before a decision is made to even add a project to the FASB’s formal agenda.

2. After more study and further hearings, the Board often issues a report summarizing its Preliminary Views.

3. Interested parties are invited to comment either in writing or orally at a public hearing.

(continued)

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4. After comments from interested parties have been evaluated, the Board meets as many times as necessary to resolve the issues.

5. From these meetings, the Board develops an Exposure Draft of a statement that includes specific recommendations for financial accounting and reporting.

6. After 60 days or longer, if the topic is a major one, all comments are reviewed by the staff and the Board.

(continued)


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7. Further deliberation of the Board leads to either the issuance of an Accounting Standards Update, a revised Exposure Draft, or, in some cases, abandonment of the project.

8. The final statement not only sets forth the actual standards but also establishes the effective date and method of transition.

9. Currently, a simple majority (three out of five) is required for approval of an Exposure Draft or a final statement of standards.


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• In an effort to overcome the methodical, sometimes slow, nature of the standard setting process, in 1984 the FASB established the Emerging Issues Task Force (EITF).

• The EITF assists the FASB in the early identification of emerging issues that affect financial reporting.

Emerging Issue Task Force

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• The official source of U.S. GAAP is called the FASB Accounting Standards Codification (ASC).

• Prior to launching of the FASB ASC in July 2009, finding a specific accounting rule on a specific topic involved a primitive hunt-and-peck strategy.

FASB Accounting Standards Codification

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Securities and Exchange Commission (SEC)

• The SEC was created by an act of Congress in 1934.

• Its primary role is to regulate the issuance and trading of securities by corporations to the general public.

• It requires companies to furnish various financial statements, and other periodic information about significant events.

• The SEC requires companies to have their external financial statements audited by independent accountants.

(continued)

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• In addition to the SEC’s rules and interpretive releases, the SEC staff issues Staff Accounting Bulletins that represent practices followed by the staff administering SEC disclosure requirements.

• The auditors of SEC-required financial information must be registered and periodically inspected by the Public Company Accounting Oversight Board (PCAOB).

Securities and Exchange Commission (SEC)

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American Institute of Certified Public Accountants (AICPA)

• The American Institute of Certified Public Accountants (AICPA) is the professional organization of practicing certified public accountants (CPAs) in the United States.

• It publishes the monthly journal, the Journal of Accountancy.

• The AICPA is responsible for preparing and grading the Uniform CPA Examination.

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• The American Accounting Association (AAA) is an organization of accounting professors.

• It sponsors national and regional meetings where accounting professors discuss technical research and share innovative teaching techniques and materials.

• It organizes working committees of professors to study and comment on accounting standards issues.

American Accounting Association

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• One of the most significant actions of the AAA is to motivate and facilitate curriculum revision to keep pace with the changes in the accounting profession.

• The AAA publishes a number of academic journals, including The Accounting Review and Accounting Horizons.

American Accounting Association

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Internal Revenue Service

• The Internal Revenue Service (IRS) has the primary goal of equitably collecting revenue.

• Although not the same, there are many areas where tax and financial accounting are closely related.

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What is GAAP?

Historically, the Auditing Standards Board of the AICPA has defined Generally Accepted Accounting Principles (GAAP) in the context of a phrase included in the standard auditor’s opinion:

““present fairly…in conformity with generally present fairly…in conformity with generally accepted accounting principles.”accepted accounting principles.”

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International Accounting Standards Board

• The international nature of business requires companies to be able to make their financial statements understandable to users all over the world.

• In an attempt to harmonize conflicting standards, the International Accounting Standards Board (IASB) was formed in 1973 to develop worldwide accounting standards.

(continued)

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• Accounting standards issued by the IASB are referred to as International Financial Reporting Standards (IFRS) if issued since 2001, and International Accounting Standards (IAS) if issued prior to 2001.

• In 2008 the SEC began allowing non-U.S. companies with shares trading on U.S. stock exchanges to issue their financial reports using IASB standards.

(continued)


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• The SEC is considering whether to allow U.S. companies to use IASB standards, rather than FASB standards, in the financial reports that they provide to their U.S. stockholders.

• If this happens, the FASB may cease to exist.

• The SEC “work plan” does not envision a U.S. switch to IFRS until 2015 at the earliest.


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Conceptual Framework

• A strong theoretical foundation is essential if accounting practice is to keep pace with a changing business environment.

• The conceptual framework plays a vital role in the development of new standards and in the revision of previously issued standards.

• The conceptual framework provides a guide for analyzing and resolving emerging issues.

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In February 2000, the FASB issued the last of seven Statements of Financial Accounting Concepts, which provide the basis for the conceptual framework.

1) Objectives of Financial Reporting by Business Enterprises

2) Qualitative Characteristics of Accounting Information

3) Elements of Financial Statements of Business Enterprises

(continued)

Concepts Statements

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4) Objectives of Financial Reporting by Nonbusiness Organizations

5) Recognition and Measurement in Financial Statements of Business Enterprises

6) Elements of Financial Statements (a replacement of No. 3, broadened to include not-for-profit as well as business enterprises) (continued)

Concepts Statements

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7) Using Cash Flow Information and Present Value in Accounting

(continued)

Concepts Statements

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The seven Concepts Statements addressed four major areas:

(continued)

Concepts Statements

1. Objectives: What are the purposes of financial reporting?

2. Qualitative characteristics: What are the qualities of useful financial information?

3. Elements: What is an asset? a liability? a revenue? an expense?

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Conceptual Framework

4. Recognition, measurement, and reporting: How should the objectives, qualities, and elements of definitions be implemented?

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Recognition, Measurement, and Reporting

• Recognition—Boiling down all the estimates and judgments into one number and using that number to make a journal entry.

• Disclosure—Skipping the journal entry and just relying on the note to convey the information to users.

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• Recognition Criteria—For an item to be formally recognized, it must meet one of the definitions of the elements of the financial statements. For example, a receivable must meet the

definition of an asset to be recorded and reported on the balance sheet.

• Disclosure is preferable to recognition in situations in which relevant information cannot be reliably measured.

(continued)


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1. Historical cost

2. Current replacement cost

3. Fair value

4. Net realizable value

5. Present (or discounted) value

Five different measurement attributes are currently used in practice.

(continued)


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Reporting—Included in the recommended set of general-purpose financial statements are reports that show the following:

Balance Balance SheetSheet

(continued)

• Financial position at the end of the period


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• Financial position at the end of the period• Earnings (net income) for the period


Income Income StatementStatement

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• Financial position at the end of the period• Earnings (net income) for the period• Cash flows during the period


Statement of Statement of cash flowscash flows

(continued)


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• Financial position at the end of the period• Earnings (net income) for the period• Cash flows during the period• Investments by and distributions to

owners during the period


(continued)

Statement of Statement of changes in changes in

owners’ equityowners’ equity


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• Financial position at the end of the period• Earnings (net income) for the period• Cash flows during the period• Investments by and distributions to

owners during the period• Comprehensive income (total non-owner

changes in equity) for the period


(continued)


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• Comprehensive income differs from earnings in that it includes unrealized gains and losses not recognized in the income statement.

• In 1998, the FASB required companies to provide, in at least one place, information relating to unrealized gains and losses.

(continued)


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Traditional Assumptions of the Accounting Model

1. Economic entity

2. Going concern

3. Arm’s-length transactions

4. Stable monetary unit

5. Accounting period

The FASB conceptual framework is influenced by five basic assumptions:

(continued)

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Impact of the Conceptual Framework

• The conceptual framework provides a basis for consistent judgments by all those involved in financial reporting.

• Related to the conceptual framework is the push toward more “principles-based” accounting standards.

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Rules vs. Principles

In July 2003, the SEC submitted a report to Congress recommending that the FASB move toward “objectives-oriented standards” which would have the following characteristics:

• Be based on an improved and consistently applied framework

• Clearly state the accounting objective of the standard

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Rules vs. Principles

• Provide sufficient detail and structure so that the standard can be operationalized and applied on a consistent basis

• Minimize exceptions from the standard

• Avoid use of percentage tests that allow financial engineers to achieve technical compliance with the standard while evading the intent of the standard

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• Pubic accountants do not work for a single business enterprise. Rather, they provide a variety of services for many different individuals and business clients.

• The four largest firms are Deloitte & Touche, Ernst & Young, KPMG, and PricewaterhouseCoopers.

Careers in Financial Accounting

Public AccountingPublic AccountingPublic AccountingPublic Accounting

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A large business enterprise employs financial accountants who are primarily concerned with external financial reporting, management accountants who are primarily concerned with internal financial reporting, and tax accountants.

Corporate AccountingCorporate AccountingCorporate AccountingCorporate Accounting


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Credit analysts, investment bankers, brokers, and business consultants need a strong working knowledge of accounting as well as strong skills in information technology.

User (Analyst, Banker, Consultant)User (Analyst, Banker, Consultant)User (Analyst, Banker, Consultant)User (Analyst, Banker, Consultant)


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The Importance of Personal Ethics

• The flexibility inherent in the assumptions underlying the preparation of financial statements means that an accountant can intentionally deceive financial statement users and still be in compliance with GAAP.

• Our financial reporting system is of limited value if the accountants who operate the system do not have strong personal ethics.

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Chapter 1Chapter 1

The EndThe EndThe EndThe End

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