the environment of financial reporting c hapter 1 notes

The Environment of Financial Reporting

Chapter 1

NOTES NOTES

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More Accountants Needed

New accounting rules pose challenges for financial accounting and projections point to increased

hiring of accounting graduates.

New accounting rules pose challenges for financial accounting and projections point to increased

hiring of accounting graduates.

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Capital Markets

Companies need large amounts of capital for operations

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Stock Exchange

Companies may obtain capital by issuing capital stock...

Capital Markets

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Bank

Capital Markets

…or by borrowing from lenders

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1. Buy. A potential investor decides to purchase a particular security on the basis of communicated accounting information.

2. Hold. An actual investor decides to retain a particular security on the basis of communicated accounting information.

3. Sell. An actual investor decides to dispose of a particular security on the basis of communicated accounting information.

External and Internal Users

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Sources of AuthoritySources of Authority

Internal needs

Managerial AccountingFinancial Accounting

GAAP

Comparison of Financial and Managerial Accounting

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Time Frame of Reported InformationTime Frame of Reported Information

Present and future

Managerial Accounting

Primarily historical

Financial Accounting


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ScopeScope

Total company


Individual departments, divisions, and total company



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Type of InformationType of Information

Primarily quantitative

Sales$275,240

Cost180,120

Gross mar. 95,120

Expenses 80,120

Net inc. $15,000


Qualitative as well as quantitative

Materials usage is

unfavorable

by $8,400.



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Statement FormatStatement Format

Prescribed by GAAP; oriented toward investment

and credit decisions


Determined by company; focused upon specific decisions being made



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Decision FocusDecision Focus

External


Internal



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The company’s accountants prepare both the financial and

the managerial accounting reports…

The company’s accountants prepare both the financial and

the managerial accounting reports…

…and the information comes from the same information system.

…and the information comes from the same information system.


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Financial reporting is the process of communicating

financial accounting information about a company

to external users.

Financial reporting is the process of communicating

financial accounting information about a company

to external users.

Financial Reporting

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1. The balance sheet (or statement of financial position), which summarizes a company’s financial position at a given date.

2. The income statement, which summarizes the results of a company’s income-producing activities for a period of time.

3. The statement of cash flows, which summarizes a company’s cash inflows and outflows for a period of time.

Companies present at least three major financial statements:

Financial Reporting

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A statement of changes in

stockholders’ equity is also included by many

companies.

A statement of changes in

stockholders’ equity is also included by many

companies.

Financial Reporting

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This statement summarizes the changes

in each item of stockholders’ equity for a

period.

This statement summarizes the changes

in each item of stockholders’ equity for a

period.

Financial Reporting

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GAAP are the guidelines, procedures, and practices that a company is required to use in recording and reporting the accounting

information in its audited financial statements.

They are like laws and are the rules that must be followed in financial reporting.

They are like laws and are the rules that must be followed in financial reporting.

Generally Accepted Accounting Principles (GAAP)

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Currently, there is no single document that includes all the accounting standards.

However, the FASB has released its FASB Accounting Standards Codification for verification by its constituents. When

finalized, this Codification will be electronic and will integrate and topically organize U.S.

accounting standards.

FASB Accounting Standards Codification

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A FASB Statements of Financial Accounting Standards and Interpretations, FASB Statement 133 Implementation Issues, FASB Staff Positions, and APB Opinions and CAP (AICPA) Accounting Research Bulletins not superceded by actions of the FASB (as well as SEC releases such as Regulation S-X, Financial Reporting Releases, and Staff Accounting Bulletins for companies that file with the SEC)

ContinuedContinuedContinuedContinued

Hierarchy of Sources of GAAP

Categories Authoritative Sources

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B FASB Technical Bulletins, and, if cleared by the FASB, AICPA Industry Audit and Accounting Guides, and AICPA Statements of Position

C FASB Emerging Issues Task Force Consensus Positions, Topics discussed in Appendix D of EITF Abstracts, and, if cleared by the FASB, AICPA Practice Bulletins




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D FASB Q’s and A’s (Implementation Guides), AICPA Accounting Interpretations, AICPA Industry and Audit Guides, and AICPA Statements of Position not cleared by the FASB, and practices that are widely recognized and prevalent either generally or in the industry (e.g., AICPA Accounting Trends and Techniques)


There are electronic databases such as the FASB Financial Accounting Research

System (FARS) that include most accounting standards

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The Codification does not change GAAP. Instead, it reorganizes the many

pronouncements on U.S. GAAP into about 90 accounting topics, organized in a

consistent structure.


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The FASB expects the Codification to: Reduce the amount of time and effort needed to

solve an accounting research issue. Improve the usability of the accounting

literature, thereby reducing the chances of not complying with GAAP.

Provide real-time updates as new standards are issued.


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The FASB expects to approve the Codification in 2009. At that time, the

Codification will supercede all then-existing non-SEC standards. Once the Codification has been approved, the FASB will not issue separate new pronouncements. Instead, any new standards will be structured in a way to

update the Codification.


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Committee on Accounting Procedure (CAP)

In 1938, the AICPA formed the Committee on Accounting Procedure (CAP). This group issued pronouncements known as Accounting Research

Bulletins (ARB), but the CAP did not have authority to enforce its pronouncements and

application was optional. The CAP was criticized because its members were all CPAs and

application was optional, so the AICPA formed the Accounting Principles Board (APB) in 1959 to replace the Committee on Accounting Procedure.

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1. To alleviate criticism about the process of formulating accounting principles, which included wider representation.

2. To create a policy-making body whose rules would be binding on companies rather than optional.

The APB was comprised 17 to 21 The APB was comprised 17 to 21 members, selected primarily members, selected primarily

from the accounting profession.from the accounting profession.

The APB was comprised 17 to 21 The APB was comprised 17 to 21 members, selected primarily members, selected primarily

from the accounting profession.from the accounting profession.

Reasons for Forming the APB

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1. Independence. The members of the APB were part-time volunteers whose major responsibilities were to the business, governmental, or academic organizations employing them.

2. Representation. The public accounting firms and the AICPA were too closely associated with the development of accounting standards.

3. Response time. Emerging problems were not solved quickly enough by the part-time members of the APB.

Criticisms of the APB

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1. Statements of Financial Accounting Standards

2. Interpretations

3. Staff Positions

4. Technical Bulletins

5. Statements of Financial Accounting Concepts

6. Other Pronouncements

Types of Pronouncements Issued by the FASB

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Other Organizations Impacting GAAP

Securities and Exchange Commission (SEC) – The SEC is a governmental agency that has the legal authority to prescribe accounting principles and reporting practices for all corporations issuing publicly traded securities.

American Institute of Certified Public Accountants (AICPA) – The AICPA is the professional organization for all certified public accountants in the United States. To be a member of the AICPA, an individual must have passed the Uniform CPA Examination, hold a CPA certificate, agree to abide by its bylaws and Code of Professional Ethics, and have 150 hours of higher education.


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FASB Emerging Issues Task Force (EITF) – The primary objectives of the EITF are (1) to identify significant emerging accounting issues (i.e., unique transactions and accounting problems) that it feels the FASB should address and (2) to develop consensus positions on the implementation issues involving the application of standards.

International Accounting Standards Board (IASB) – The IASB issues International Financial Reporting Standards (IFRS) and includes 12 full-time members (and 2 part-time members) from various countries. To date, the IASB has issued 49 Standards.


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Governmental Accounting Standards Board (GASB) – The GASB’s responsibility is to establish financial accounting standards for certain state and local governmental entities.

Public Company Accounting Oversight Board (PCAOB) – The PCAOB is a non-profit corporation that was created by Congress in the Sarbanes-Oxley Act of 2002. Its purpose is to protect the interests of investors by overseeing auditors of public companies in the preparation of informative, accurate, and independent audit reports for companies that sell securities to the public.



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Cost Accounting Standards Board (CASB) – The CASB is responsible only for negotiated federal contracts and subcontracts exceeding $500,000.

Internal Revenue Service (IRS) – The IRS administers the Internal Revenue Code enacted by Congress.

American Accounting Association (AAA) – The AAA is an organization primarily of academics and practicing accountants.



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Financial Executives International (FEI) – The FEI consists primarily of high-level financial executives (such as financial vice-presidents, treasures, and controllers) of major corporations. The FEI publishes a monthly journal called the Financial Executive.

Institute of Management Accountants (IMA) – The primary focus of the IMA is on management accounting and financial accounting issues. The IMA publishes a monthly journal called Strategic Finance.



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CFA Institute (CFAI) – Members of the CFAI are financial analysts who use accounting information in various investment management and security analysis decisions.


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ResponsibilitiesResponsibilities

In carrying out their responsibilities as

professionals, members should exercise sensitive professional

and moral judgments in all their activities.

In carrying out their responsibilities as

professionals, members should exercise sensitive professional

and moral judgments in all their activities.

Principles of the AICPA Code of Professional Conduct

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The Public InterestThe Public Interest

Members should accept the obligation to act in a way that will serve the public interest, honor the

public trust, and demonstrate commitment to professionalism.

Members should accept the obligation to act in a way that will serve the public interest, honor the

public trust, and demonstrate commitment to professionalism.


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IntegrityIntegrity

To maintain and broaden public confidence, members

should perform all professional responsibilities

with the highest sense of integrity.

To maintain and broaden public confidence, members

should perform all professional responsibilities

with the highest sense of integrity.


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Objectivity and IndependenceObjectivity and Independence

A member should maintain objectivity and be free from conflicts of interest in discharging professional responsibilities. A member in public

practice should be independent in fact and appearance.

A member should maintain objectivity and be free from conflicts of interest in discharging professional responsibilities. A member in public

practice should be independent in fact and appearance.


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Due CareDue Care

A member should observe the profession’s technical and ethical standards, strive continually to

improve competence and the quality of services, and discharge the

professional responsibility to the best of the member’s ability.

A member should observe the profession’s technical and ethical standards, strive continually to

improve competence and the quality of services, and discharge the

professional responsibility to the best of the member’s ability.


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Scope and Nature of ServiceScope and Nature of Service

A member in public practice should observe the Principles of

the CPC in determining the scope and nature of services to

be provided.

A member in public practice should observe the Principles of

the CPC in determining the scope and nature of services to

be provided.


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1. The utilitarian model, which evaluates actions based on the “greatest good for the greatest number.”

2. The rights model, which embraces actions that protect individual moral rights.

3. The justice model, which emphasizes a fair distribution of benefits and burdens.

An Ethicist’s Basic Approaches to Moral Reasoning

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IFRS and U.S. GAAP

Many companies have become “globalized.” Currently, U.S. corporations are subject to the accounting standards established by the FASB, while foreign corporations are subject to international financial reporting standards (IFRS) established by the IASB or by accounting standards set by their national accounting standards board. These differences in accounting standards have led to differences among U.S. and foreign corporations’ financial statements. These differences, in turn, have made it difficult for investors and creditors to make valid comparisons across corporations and to make effective buy-sell-hold decisions in the U.S. and foreign capital markets.

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IFRS and U.S. GAAP

To resolve this issue, FASB and the IASB entered into an agreement (Norwalk) to develop high-quality, compatible accounting standards that could be used for both “domestic” and “cross-border” financial reporting. To achieve this compatibility, the Boards agreed to work together to achieve “short-term” convergence on a number of individual differences between U.S. and international accounting standards.

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Chapter 1

the environment of financial reporting c hapter 1 notes

Documents

scopecomparison of financial

financial reporting

companys financial position

staff accounting bulletins

major financial statements

audited financial statements

statement of changes

income statement