Chapter 1: Accounting: Concepts, Standards and Practice

1
Chapter 1 AccountingConcepts, Standards and
Practice
2
Class Case

• On 1/1/2005 Dan decided to start his own
  airport shuttle business. On the same day he
  bought a used van for 5,500, paid 2,000 for
  annual registration, taxes and permits and
  started to drive passengers from to the
  airport. By 1/31/2005, Dan serviced over 300
  (happy?) passengers and collected a total of
  8,000. Some passengers still owe Dan a total of
  500 for their trips. Dan paid 4,500 for
  miscellaneous costs and still owes 1,200 on his
  credit card for additional expenses. By the end
  of the month Dan experienced trouble with the van
  and scheduled to bring it in for repair on
  2/1/2005. He expects to pay about 1,000 for the
  repairs.
• What was Dans gain or loss for the month of
  January 2005?

3
Financial Accounting Big Picture
GAAP (Generally Accepted Accounting Principles)
The Accounting Information System
Financial Statements
Conceptual framework
Parties involved in Standard Setting
4
Todays Class Objectives
5
Introduction Financial Statements

• External financial statements include
• Balance Sheet
• (also called Statement of Financial Position)
• Income Statement
• Statement of Stockholders Equity
• (alternatives Statement of Owners Equity)
• Statement of Cash Flows

6
Introduction Financial Statements

• Primary external users are
• Current and potential investors
• Creditors
• Competitors
• Regulatory agencies
• Employees

7
Development of GAAP - Generally Accepted
Accounting Principles

• Accounting standards used today are referred to
  as Generally Accepted Accounting Principles
  (GAAP).
• These principles are "generally accepted" because
  an authoritative body has set them or the
  accounting profession widely accepts them as
  appropriate.

8
Development of GAAP AICPA

• AICPA (American Institute of Certified Public
  Accountants)
• Professional organization for public accountants.
• Prepares the CPA examination.
• AcSEC (Accounting Standards Executive Committee)
  issues SOPs (Statements of Position), Audit and
  Accounting Guidelines, Practice Bulletins.
• Issues auditing standards (SASs), Attestation
  Standards, and Quality Control Standards.
• Starting 2004, the PCAOB (Public Company
  Accounting Oversight Board) develops auditing
  standards for publicly traded companies.
• The APB (Accounting Principles Board) issued
  opinions (Standards) until 1973.

9
Development of GAAP FASB

• The mission of the Financial Accounting Standards
  Board (FASB) is to establish and improve
  standards of financial accounting and reporting
  for the guidance and education of the public,
  including issuers, auditors, and users of
  financial information.

10
Development of GAAP FASB

• FASB (Financial Accounting Standards Board)
• Established in 1973.
• Funded by the FAF (Financial Accounting
  Foundation).
• Advised by the FASAC (Financial Accounting
  Standards Advisory Council).
• Independent board (not part of AICPA).
• 7 full-time, well-paid, independent board members.

11
Development of GAAP FASB

• Primary FASB pronouncement is the Statement of
  Financial Accounting Standard
• Process for developing a SFAS
• Research
• Discussion Memorandum
• Hearings
• Exposure Draft
• Standard

12
Development of GAAP FASB

• Other FASB pronouncements
• Interpretations - modify/extend SFASs.
• Technical Bulletins - provide guidance.
• SFACs (Statements of Financial Accounting
  Concepts) - not GAAP, but used to develop GAAP.
• EITFS (Emerging Issues Task Force Statements)-
  timely guidance for unusual financial
  transactions.
• Criticism of FASB

Standards too costly and complex. Compromises
perceived as weakness.
13
Development of GAAP SEC

• The primary mission of the U.S. Securities and
  Exchange Commission (SEC) is to protect investors
  and maintain the integrity of the securities
  markets.

14
Development of GAAP SEC

• SEC (Securities and Exchange Commission)
• Federal agency which administers the Securities
  Exchange Act of 1934 and several other acts.
• has the mandate to establish accounting
  standards.
• Relies on the AICPA and FASB to set accounting
  standards.
• Enforces accounting and disclosure standards.
• Chief Accountant of SEC sits on EITF (Emerging
  Issues Task Force) of the FASB.

15
PCAOB (Public Company Accounting Oversight Board)

• A private-sector, non-profit corporation, created
  by the Sarbanes-Oxley Act of 2002, to oversee the
  auditors of public companies in order to protect
  the interests of investors and further the public
  interest in the preparation of informative, fair,
  and independent audit reports.
• Has the authority for registration, inspection,
  and discipline of firms auditing SEC registrants
• Sets standards for public company audits

16
Development of GAAP Other Influential
Organizations

• IRS (Internal Revenue Service)
• AAA (American Accounting Association)
• FEI (Financial Executives Institute)
• IMA (Institute of Management Accountants)
• FAF (Financial Analysts Federation)
• GASB (Governmental Accounting Standards Board)
• U. S. Congress

17
Key Accounting Organizations - US
Public Sector (SEC)
GAAP
18
Development of GAAP International Accounting
Standards Committee

• The International Accounting Standards Committee
  (IASC) encourage international cooperation in
  developing consistent worldwide accounting
  principles.
• In 2001, the IASC was succeeded by the
  International Accounting Standards Board (IASB).

19
Development of GAAP International Accounting
Standards Board

• The International Accounting Standards Board
  (IASB) is an independent, privately-funded
  accounting standard-setter based in London, UK.
• The IASB is committed to developing, in the
  public interest, a single set of high quality,
  understandable and enforceable global accounting
  standards that require transparent and comparable
  information in general purpose financial
  statements.

20
Development of GAAP International Accounting
Standards Board

• In addition, the IASB co-operates with national
  accounting standard-setters to achieve
  convergence in accounting standards around the
  world.
• European Commission presents legislation to
  require use of IASC Standards for all listed
  companies no later than 2005.

21
The House of US GAAP
Kieso Weygandt
22
Todays Class Objectives
23
Financial Accounting Concepts -
Objectives of Financial Reporting

• Provide information useful to business
  decision-makers.
• Provide Information useful in predicting future
  performance and cash flows of the company.
• Provide Information useful to analysts and
  investors to verify predictions (feedback).
• Book Chapter 1, page 5.

24
Financial Accounting Concepts -
Qualitative Characteristics

• Decision Usefulness - contribute to the decision
  making process.
• Relevance makes a difference in a decision.
• Reliability verifiable, free from bias,
  representational faithfulness.
• relevance and reliability may be in conflict
  (example fair value versus historical cost).
• Understandability - enables users to perceive the
  significance of information.

25
Financial Accounting Concepts -
Qualitative Characteristics

• Comparability - ability to compare financial
  information across firms.
• Consistency ability to compare financial
  information across years for a single firm.
• Cost/benefit - the cost of implementing a
  standard should not exceed the benefits to the
  users.
• Book Illustration 4, chapter 1, p. 6-8

26
Financial Accounting Concepts - Basic
Assumptions and Principles

• Basic assumptions and principles are the
  foundation of GAAP. They are expressed in the
  SFACs (Statements of Financial Accounting
  Concepts) of the FASB.
• The concepts do not constitute GAAP, but are used
  to develop the standards that represent GAAP.
• Book Illustration 5, chapter 1, p. 8-11

27
Financial Accounting Concepts - Basic
Assumptions

• Entity Assumption
• assets and liabilities of reporting entity are
  separate from those of the owners.
• Going Concern
• assumes the entity will not be liquidated in the
  near future.
• Stable Monetary Unit
• all monetary units are of equal worth
• Time Period Assumption
• information is presented in discrete time periods
  (years, quarters, months).

28
Financial Accounting Concepts - Basic
Principles

• Historical Cost
• assets recorded at their historical acquisition
  price.
• Revenue Recognition
• revenue is recognized when earnings process
  substantially complete (generally, when goods and
  services are delivered).
• Matching
• expenses incurred to generate revenues should be
  recorded in the same period.
• Full Disclosure
• all information needed by decision-makers should
  be included in the financials or in the notes.

29
Exceptions (Constraints) to the Basic
Assumptions and Principles

• These exceptions contradict the basic principles,
  in certain circumstances. They are
• Materiality (the immateriality constraint)
• Only transactions with amounts large enough to
  make a difference are considered material.
• Nonmaterial transactions can be given alternative
  treatments.
• Conservatism - when in doubt
• Understate assets.
• Overstate liabilities.
• Accelerate recognition of losses.
• Delay recognition of gains.

30
Ex. 1-25

• Given the following assumptions, principles and
  constraints
• 1. Comparability
• 2. Conservatism
• 3. Consistency
• 4. Entity
• 5. Going-concern
• 6. Historical cost
• 7. Matching
• 8. Materiality
• 9. Stable monetary unit (includes "monetary"
  recording of transactions in dollars)

31
Ex. 1-25

• Match the numbers to the letters below. The
• information in your text is abbreviated to the
  right
• ____ a. Match expenses of a period to revenues
  earned during that period.
• ____ b. Assume that all transactions are recorded
  in terms of dollars.
• ____ c. Assumes fluctuations in purchasing power
  of the dollar are not material.
• ____ d. Assumes the accountant should focus on
  transactions that are of significance to users of
  the financial report.
• ____ e. When choosing from equal alternatives,
  choose the one least likely to overstate assets
  and income.

7
9
9
8
2
32
Ex. 1-25
3

• ____ f. Once a particular accounting method is
  adopted, a firm must continue to use that method
  for other similar transactions.
• ____ g. Original acquisition cost, not
  replacement cost, is the basis to be used in most
  accounting transactions.
• ____ h. Similar information of different
  enterprises can be compared, and information from
  different periods can be compared.
• ____ i. Distinction is made between a business
  and its owners.
• ____ j. Assumption is made that the business will
  operate indefinitely.

6
1
4
5