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Environment and Theoretical

Structure of Financial Accounting
Chapter 1
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Financial Accounting Environment
Profit-oriented
companies

Not-for-profit
entities

Providers of
Financial
Information
External
User Groups
Investors
Creditors
Employees
Labor unions
Customers
Suppliers
Government
agencies
Financial
intermediaries
Relevant
Financial
Information
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The Economic Environment
and Financial Reporting
A sole proprietorship
is owned by a
single individual.
A partnership is
owned by two or
more individuals.
A corporation is owned
by shareholders.
A highly-developed
system communicates
financial information
from a corporation to its
many shareholders.
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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
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Cash versus Accrual Accounting
Cash Basis Accounting
Revenue is recognized when cash is received.
Expenses are recognized when cash is paid.
O
R
O
R
O
R
OR
Accrual Accounting
Revenue is recognized when earned.
Expenses are recognized when incurred.


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Cash versus Accrual Accounting
Cash Basis Accounting
Carter Company has sales on account totaling
$100,000 per year for three years. Carter collected
$50,000 in the first year and $125,000 in the second
and third years. The company prepaid $60,000 for
three years rent in the first year. Utilities are $10,000
per year, but in the first year only $5,000 was paid.
Payments to employees are $50,000 per year.

Lets look at the cash flows.
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Cash versus Accrual Accounting
Cash Basis Accounting
Year 1 Year 2 Year 3 Total
Sales (on credit) 100,000 $ 100,000 $ 100,000 $ 300,000 $
Cash receipts from
customers 50,000 $ 125,000 $ 125,000 $ 300,000 $
Payment of 3
years' rent (60,000) - - (60,000)
Salaries to
employees (50,000) (50,000) (50,000) (150,000)
Payments for
utilities (5,000) (15,000) (10,000) (30,000)
Net cash flow (65,000) $ 60,000 $ 65,000 $ 60,000 $
Summary of Cash Flows
Cash flows in any one year may not
be a predictor of future cash flows.
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Cash versus Accrual Accounting
Accrual Basis Accounting
Year 1 Year 2 Year 3 Total
Revenue 100,000 $ 100,000 $ 100,000 $ 300,000 $
Rent Expense (20,000) (20,000) (20,000) (60,000)
Salaries Expense (50,000) (50,000) (50,000) (150,000)
Utilities Expense (10,000) (10,000) (10,000) (30,000)
Net Income 20,000 $ 20,000 $ 20,000 $ 60,000 $
Summary of Operations
Net Income is considered a better indicator
of future cash flows.
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The Development of Financial
Accounting and Reporting Standards
Concepts,
principles, and
procedures were
developed to meet the
needs of external
users (GAAP).
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Current Standard Setting
Supported by the Financial Accounting Foundation
Seven full-time, independent voting members
Members not required to be CPAs
Financial Accounting
Standards Board
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Accounting Standard-Setting


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FASB Accounting Standards
Codification
The objective of the codification project was to integrate and
organize by topics all relevant accounting pronouncements
into a searchable, online database.
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FASBs Standard-Setting Process
1. Board receives recommendations for projects.
2. Board votes to add the project to its agenda .
3. Board deliberates the issues at a series of public
meetings.
4. Board issues an Exposure Draft (ED).
5. Board holds a public roundtable meeting on the ED.
6. Staff analyzes feedback and the Board re-deliberates
the proposed revisions at public meetings .
7. Board issues a Standards Update describing
amendments to the Codification.
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Global Accounting Standards
The main objective of the International
Accounting Standards Board (IASB) is to
develop a single set of high quality,
understandable and enforceable global
accounting standards.
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Efforts to Converge U.S. and
International Standards
Issues and Concerns:
Desire for a single set of global standards
Need for standards that are customized to fit stringent legal
and regulatory requirements of U.S.
Possible differences in implementation and enforcement





Progress:
September 2002: FASB and IASB sign Norwalk Agreement.
November 2008: SEC issues a Roadmap with milestones.
Nov 2011: SEC postpones making convergence decision.
July 2012: SEC issues final report on 2-yr adoption study.
July 2012: Chief Acct. J. Kroeker resigns.
Dec. 2012: M. Schapiro steps down as SEC Chair.
Currently SEC seemingly backs away from convergence.



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Role of the Auditor
Auditors serve as independent
intermediaries to help insure that
management has appropriately applied
GAAP in preparing the companys
financial statements.
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The Conceptual Framework
The Conceptual Framework has been described as
an Accounting Constitution. It provides the
underlying foundation for accounting standards.
FASB Conceptual Framework
(Statements of Financial Accounting Concepts)
Objectives of Financial Reporting (SFAC 1, replaced by
SFAC 8)
Qualitative Characteristics (SFAC 2, replaced by SFAC 8)
Elements of Financial Statements (SFAC 3, replaced by
SFAC 6)
Recognition and Measurement (SFAC 5 and SFAC 7)
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Objective
To provide financial information
that is useful to capital providers.
Elements
Financial
Statements Constraints
The Conceptual Framework
Recognition and
Measurement
Concepts
Fundamental and
Enhancing
Qualitative
Characteristics
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Relevance Faithful representation
Predictive
value
Confirmatory
value
Neutrality Completeness
Free from
material error
Qualitative Characteristics of
Accounting Information
Comparability
(Consistency)
Understandability Verifiability Timeliness
Decision usefulness
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Practical Boundaries (Constraints) to
Achieving Desired Qualitative Characteristics
Cost
Effectiveness
Materiality
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Elements of Financial Statements
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Elements of Financial Statements
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Underlying Assumptions and
Accounting Principles
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Recognition, Measurement and
Disclosure Concepts
Recognition
Process of admitting information
into the basic financial statements
Criteria:
1. Definition
2. Measurability
3. Relevance
4. Reliability
Measurement
Process of associating numerical
amounts with the elements.
Measurement Attributes:
1. Historical cost
2. Net realizable value
3. Current cost
4. Present value of
future cash flows
5. Fair value
Disclosure
Process of including additional
supplemental information.
Examples:
1. Parenthetical
amounts
2. Notes to FS
3. Supplemental FS
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Fair Value Hierarchy
U.S. GAAP gives companies the option to report some or
all of their financial assets and liabilities at fair value.