3 Generally Accepted Accounting Principles (GAAP) Ensure that financial statements are meaningful and useful.Are used whether the business is large or small.Allow financial statements of different companies to be compared.Allow a company to compare its own financial statements from period to period.Financial transactions and financial statements are prepared using accounting rules and principles.Owners, suppliers, investors, and others rely on financial records. Users can be satisfied only if a consistent set of rules, procedures, and principles of accounting are accepted and used.
4 Accepted Accounting Principles The Development of GenerallyAccepted Accounting PrinciplesObjective 1In the United States, accounting principles are developed through a cooperative effort between the public sector and private sector.Public sector government represented by SECHow are GAAP developed?In the United States, accounting principles are developed through a cooperative effort between the public sector and private sector.Private sector business represented by FASB
5 Objective 2Identify the major accounting standards-setting bodies and their roles in the standards-setting process.Who are the major accounting standards-setting bodies in the U.S.?
6 Securities and Exchange Commission Regulates all publicly held companies and all companies with more than a specified number of shareholders or owners.Determines the form and content of accounting reports filed by companies under its jurisdiction.Has authority to define accounting terms and to prescribe accounting principles.Lets the accounting profession develop principles and standards, but has the final authority.The SEC is a legal rule-making body and represents the public sector.
7 Financial Accounting Standards Board Seven member board — each having distinguished accounting backgrounds — who are full-time employees.Responsible for developing financial accounting standards and principles.Develops and issues Statements of Financial Accounting Standards.Has issued about 150 standards that the SEC recognizes as authoritative.The FASB represents the private sector. The FASB is responsible for developing financial accounting standards and principles. The authoritative financial accounting pronouncements of the FASB are know as Statements of Financial Accounting Standards.
8 American Institute of Certified Public Accountants (AICPA) In the past, GAAP were developed by AICPA committees.In 1972 the AICPA and other organizations formed the FASB.The AICPA requires its members to confirm that audited companies follow the FASB Statements of Financial Accounting Standards.The American Institute of Certified Public Accountants (AICPA) is a national professional organization of certified public accountants. The major functions of the AICPA are:Issuing Accounting and Auditing GuidesIssuing Statements of Position which provide guidance on financial accounting questions.Issuing Practice Bulletins which express the AICPA’s position on narrow accounting issues.
9 Federal and State Agencies Require detailed systems of accounting for public utilities.Issue income tax rules for companies (IRS).Some companies adopt tax accounting rules forfinancial records, provided the rules don’t conflictwith GAAP.Strong influencing agencies include regulatory agencies for public utility companies and the IRS.
10 Other Organizations AAA (American Accounting Association) NYSE (New York Stock Exchange)IASC (International Accounting Standards Committee)Other organizations that play a role in developing accounting principles are:AAA (American Accounting Association)NYSE (New York Stock Exchange)IASC (International Accounting Standards Committee)
11 American Accounting Association (AAA) Has members who:teach accounting;write textbooks and articles.Stimulates the acceptance of accounting principles.About half of the of members of the American Accounting Association (AAA) teach accounting.
12 New York Stock Exchange (NYSE) Required corporations to publish annual reports as early as 1900.Required independent audits for corporations since 1933.The New York Stock Exchange (NYSE) has been instrumental in the development of accounting principles and rules.
13 International Accounting Standards Board (IASB) Wants to develop standards that can be adopted throughout the world.Has issued about 50 international accounting standards.The International Accounting Standards Board, IASB, was formed to develop accounting standards that can be adopted throughout the world.In an important move, in 2002 the European Unionvoted to require companies whose securities aretraded on exchanges in member countries toprepare financial reports on the basis of IASBStandards.
14 Describe the Users and Uses of Financial Reports Objective 3The FASB has concluded that financial reporting rules should focus on providing information to investors and creditors.The focus is not onmanagementtaxauthoritiesregulatoryagenciesThere are all kinds of groups, organizations and individuals who use financial reports.Financial reporting rules are primarily concerned with providing information that is helpful to current and potential investors and creditors so that they can make better investment and credit decisions. Investors and creditors expect to receive a cash flow directly or indirectly from the business entity.Financial report users need information about: Profits, Assets, Claims against the assets (liabilities and owner’s equity) andInformation about changes in assets and the claims against the assets.
16 FASB’s framework of accounting can be divided into four categories: Qualitative CharacteristicsBasic AssumptionsBasic Accounting PrinciplesModifying ConstraintsThe Financial Accounting Standards Board focus of accounting can be divided into four main categories:Qualitative characteristicsBasic AssumptionsBasis Accounting Principles andModifying Constraints
17 Qualitative Characteristics Objective 4Identify and explain the qualitative characteristics of accounting informationQualitative CharacteristicsUsefulnessUnderstandabilityRelevanceReliabilityNeutralityComparabilityCompletenessThe fourth objective of this chapter is to identify and explain the qualitative characteristics of accounting information.Qualitative characteristics of accounting information include: usefulness, understandability, relevance, reliability, neutrality, comparability, and completeness.
18 Qualitative Characteristics UsefulnessInformation should be useful to decision makers.Usefulness means that accounting information should be useful to decision makers.
19 Qualitative Characteristics UnderstandabilityThe information should be presented in a clear and understandable manner assuming users have some basic knowledge of business and economics.Understandability means that accounting information should be presented in a manner that is clear and understandable – assuming users have some basic knowledge of business and economics.
20 Qualitative Characteristics RelevanceThe information should be appropriate for and have a bearing on decisions to be made by the users.Timeliness—The information should be reported promptly so that it can be used in making current business decisions.The information provided should have both predictive and feedback value.Relevance means that accounting information should be appropriate for and have a bearing on decisions to be made by it’s ultimate users. Implicit too is that relevant accounting information should be given in a timely manner and have both predictive and feedback value.
21 Qualitative Characteristics ReliabilityThe information should be dependable, that is, free from error and also free from any bias on the part of the preparer.Verifiability— Implies that supporting documents such as checks, invoices, and contracts support the information supplied in the financial statements and that they are available for examination.Representational Faithfulness – Implies that the data shown in the financial reports reflect what really happened.Reliability means that accounting information should be free from error and free from preparer bias. Reliability also implies that accounting information provided in financial statements can be verified by appropriate examination.Representative Faithfulness implies that the data shown in the financial reports reflect what really happened.
22 Qualitative Characteristics NeutralityThe information should not favor one group of users over another group. The information should be prepared in such a way that it is helpful to all groups.Neutrality means that accounting information should be presented in a neutral fashion – meaning that is does not favor one group of users over others. The same accounting information should be available to all users.
23 Qualitative Characteristics ComparabilityThe information should be presented so that it can be compared with the financial statements of other businesses as well as previous financial statements of the business itself.Comparability means that accounting information should be presented so that it can be compared to prior financial statements of the business itself, as well as to its competitors.
24 Qualitative Characteristics ConsistencyMeans that an entity uses the same accounting treatment for similar events and data from period to period.Consistency means that accounting information is developed using the same accounting standards and principles as applied in previous years. That way users of financial information can be assured that the numbers they are looking at are comparable.
25 Underlying Assumptions Describe and explain the basic assumptions about accounting reportsObjective 5Underlying AssumptionsSeparate Economic EntityGoing ConcernMonetary UnitPeriodicity of IncomeFour basic assumptions underlying all accounting information include: the separate economic entity concept; the going concern principle; the monetary unit concept; and the periodicity of income principle.
26 assumes that the business is separate from its owners. QUESTION:What is the separate economic entity assumption?ANSWER:The separate economic entity assumptionassumes that the business is separate fromits owners.What is the separate economic entity assumption? It assumes accounting information of a business is kept separate from that of the business owners.
27 What is the going concern assumption? QUESTION:What is the going concern assumption?The going concern assumption is the concept that a firm will continue to operate indefinitely.ANSWER:What is the going concern assumption? It assumes that a business will continue to operate as it has been indefinitely and will not be closed in the foreseeable future.
28 What is the monetary unit assumption? QUESTION:What is the monetary unitassumption?The monetary unit assumption is the concept that records are kept in terms of money and the value of money is stable.ANSWER:What is the monetary unit assumption? This means that financial statements are reported in terms of money that is the same from period to period, and that the value of this money is stable.
29 What is the periodicity of income assumption? QUESTION:What is the periodicity of incomeassumption?The periodicity of income assumption is the concept that income should be reported in certain time periods.ANSWER:What is the periodicity of income assumption? This is the concept that states income should be reported in certain time periods.
30 Explain and apply the basic principles of accounting Objective 6General PrinciplesHistorical Cost BasisRevenue RecognitionMatchingFull DisclosureThe sixth objective of this chapter is to explain and apply the basic principles of accounting.Four important generally accepted accounting principles include the historical cost basis, the revenue recognition principle, the concept of matching, and the full disclosure principle.
31 What is the historical cost basis principle? QUESTION:What is the historical cost basis principle?The historical cost basis principle is the principle that requires assets to be recorded at their cost at the time they are acquired.ANSWER:What is the historical cost basis principle? It’s the principle that requires assets to be recorded at their historical cost when acquired. The assets costs will continue to be reported on the financial statements even if their fair market value differs.
32 What is recognition of revenue? QUESTION:What is recognition of revenue?Recognition is determining the period in which to record revenue and report it on the income statement.ANSWER:What is the recognition of revenue? The recognition of revenue principle determines which accounting period to record revenue and to report it on the income statement. The recognition of revenue principle states that revenue should only be recognized in the period it was earned, and only if it has been realized.
33 What is the matching principle? QUESTION:What is the matching principle?The matching principle is the concept that revenue and costs incurred in earning that revenue should be matched in the appropriate accounting period.ANSWER:What is the matching principle? The matching principle states that costs should be matched to the revenue they helped produce in the same accounting period.
34 What is the full disclosure principle? QUESTION:What is the full disclosure principle?The full disclosure principle is the requirement that all information that might affect the user’s interpretation of financial statements be disclosed in the statements or in the footnotes.ANSWER:What is the full disclosure principle? The full disclosure principle requires that all information that might affect the user’s interpretation of financial statements be reported and disclosed in the statements themselves or in the footnotes to those financial statements.
35 Modifying Constraints Describe and apply the modifying constraints on accounting principlesObjective 7Modifying ConstraintsMaterialityCost-Benefit TestConservatismIndustry PracticeThe seventh objective of the chapter is to describe and apply the modifying constraints of accounting principles.Modifying constraints placed on accounting principles include: materiality; the cost-benefit test; conservatism; and industry practice.
36 QUESTION:What is materiality?Materiality is the significance of an item in relation to a particular situation or set of facts.ANSWER:What is materiality? Materiality is the significance of an item in relation to a particular situation or set of facts.
37 What is the Cost Benefit Test? QUESTION:What is the Cost Benefit Test?Cost Benefit Test says that the cost of gathering information to fully comply with an accounting principle or rule may be much higher than the benefit revealed. (Example, creating a depreciation schedule to depreciate the cost of a trash can or stapler)ANSWER:What is the cost benefit test? The cost of gathering information to fully comply with an accounting principle or rule may be much higher that the benefit revealed. For example, the cost of creating a depreciation schedule for a stapler far outweighs the benefit to be derived – it would simply be easier to expense the cost of the stapler as part of office supplies.
38 QUESTION:What is conservatism?Conservatism is the concept that revenue and assets should be understated rather than overstated if GAAP allows alternatives.ANSWER:What is conservatism? Conservatism is the concept that revenue and assets should be understated rather than overstated if generally accepted accounting principles allow for selection of alternative measures. Conservatism in accounting is the idea that “when in doubt, take the conservative action.”
39 What is Industry Practice? QUESTION:What is Industry Practice?Some industries have unusual tax laws or regulatory requirements and so have developed special accounting principles and procedures for their industry.ANSWER:What is industry practice? Industry practice allows some companies that have unusual tax and/or regulatory requirements to develop special accounting principles just for their industry.