1 An electronic presentation by Douglas Cloud by Douglas Cloud Pepperdine University Pepperdine University An electronic presentation by Douglas Cloud by Douglas Cloud Pepperdine University Pepperdine University

2 The Environment of Financial Reporting C hapter 1

3 1.Understand capital markets and decision making. 2.Know what is included in financial reporting. 3.Explain generally accepted accounting principles (GAAP) and the sources of GAAP. 4. Identify the types of pronouncements issued by the FASB. Objectives ContinuedContinued

4 5.Understand how the Financial Accounting Standards Board (FASB) operates. 6.Describe the relationship between the Securities and Exchange Commission (SEC) and the FASB. 7.Use ethical models for decision making about ethical dilemmas. 8.Understand creative and critical thinking. Objectives

5 Companies need large amounts of capital for operations.

6 Companies may obtain capital by issuing capital stock... Stock Exchange

7... or by borrowing from lenders. Bank

8 Capital Markets Corporations Financial InstitutionsInvestors Borrow money Sell stocks and bonds Primary Market (e.g., individuals, banks) Secondary Market (e.g., New York Stock Exchange) Buy and sell stocks and bonds Investors Buy and sell stocks and bonds

9 Accounting Information Economic Activities and Decision Making Accumu- late Accounting Information Communi- cate External User Internal User External Decisio n Making Internal Decisio n Making Company’s Economic Activities Impact

10 External and Internal Users 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.

11 Comparison of Financial and Managerial Accounting Sources of Authority Internal needs Managerial Accounting Financial Accounting GAAP

12 Time Frame of Reported Information Comparison of Financial and Managerial Accounting Present and future Managerial Accounting Primarily historical Financial Accounting

13 Scope Comparison of Financial and Managerial Accounting Mainly total company Financial Accounting Individual departments, divisions, and total company Managerial Accounting

14 Type of Information Comparison of Financial and Managerial Accounting Primarily quantitative Sales$275,240 Cost180,120 Gross mar.95,120 Expenses 80,120 Net inc.$15,000 Financial Accounting Qualitative as well as quantitative Materials usage is unfavorable by $8,400. Managerial Accounting

15 Statement Format Comparison of Financial and Managerial Accounting Prescribed by GAAP; oriented toward investment and credit decisions Financial Accounting Determined by company; focused upon specific decisions being made Managerial Accounting

16 Decision Focus Comparison of Financial and Managerial Accounting External Financial Accounting Internal Managerial Accounting

17 The company’s accountants prepare both the financial and the managerial accounting reports… …and the information comes from the same information system.

18 Financial Reporting Financial reporting is the process of communicating financial accounting information about a company to external users.

19 The balance sheet (or statement of financial position) which summarizes a company’s financial position at a given date. The income statement which summarizes the results of a company’s income producing activities for a period of time. 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

20 A statement of changes in stockholders’ equity also is included by many companies. This statement summarizes the changes in each item of stockholders’ equity for a period. Financial Reporting

21 Generally Accepted Accounting Principles (GAAP) 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.

22 Hierarchy of Sources of GAAP A.Pronouncements of authoritative bodies (FASB, APB, CAP, SEC). B.Pronouncements of bodies of expert accountants that have been exposed for public comment. C.Pronouncements of bodies of expert accountants that have not been exposed for public comment. ContinuedContinued

23 D.Widely accepted practices and pronouncements representing prevalent practice in a particular industry or applications to specific circumstances. E.Other accounting literature. Hierarchy of Sources of GAAP

24 History of GAAP in the Private Sector 1938 CAP formed CAP issued 51 ARBs APB issued 31 Opinions 1959 APB formed 1973 FASB formed Present FASB issued 145 Statements of Standards as of 5/02

25 Reasons for Forming APB 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 members, selected primarily from the accounting profession.

26 Criticisms of the APB 1.Independence. The members of the APB were part-time volunteers whose major responsibilities were to the business, governmental, or academic organization 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.

27 Structure of the FASB Financial Accounting Standards Advisory Council (approximately 30 members) Financial Accounting Standards Board (7 members) Appoint, fund, and oversee Advise Financial Accounting Foundation (16-member board of trustees) ContinuedContinued

28 Financial Accounting Standards Board (7 members) Task Forces of the Standards Board (including Emerging Issues Task Force) Appoint Consult Support Administrative Staff Research and Technical Staff Consult Structure of the FASB

29 Types of Pronouncements Issued by the FASB Statements of Financial Accounting Standards Interpretations Technical Bulletins Statements of Financial Accounting Concepts Other Pronouncements

30 FASB Operating Procedures Identify Topic Appoint Task Force Conduct Research Issue Discussion Memorandum or Invitation to Comment Issue Exposure Draft ContinuedContinued Deliberate on Findings Hold Public Hearings

31 Modify Exposure Drafts Vote (super- majority) Issue Exposure Draft Hold Public Hearings FASB Operating Procedures From previous page Issue Statement

32  Securities and Exchange Commission (SEC)  American Institute of Certified Public Accountants (AICPA)  FASB Emerging Issues Task Force (EITF)  Cost Accounting Standards Board (CASB)  Internal Revenue Service (IRS)  American Accounting Association (AAA)  Securities and Exchange Commission (SEC)  American Institute of Certified Public Accountants (AICPA)  FASB Emerging Issues Task Force (EITF)  Cost Accounting Standards Board (CASB)  Internal Revenue Service (IRS)  American Accounting Association (AAA) Other Organizations Impacting GAAP ContinuedContinued

33  International Accounting Standards Committee (IASC)  Governmental Accounting Standards Board (GASB)  Financial Executives International (FEI)  Institution of Management Accountants (IMA)  Association for Investment Management and Research (AIMR)  International Accounting Standards Committee (IASC)  Governmental Accounting Standards Board (GASB)  Financial Executives International (FEI)  Institution of Management Accountants (IMA)  Association for Investment Management and Research (AIMR) Other Organizations Impacting GAAP

34 Participants in the Development of GAAP EITF CASB GASB IMA IRSIASC AAA AIMR FEI G4+1 FASB SECAICPA

35 Principles of the AICPA Code of Professional Conduct Responsibilities In carrying out their responsibilities as professionals, members should exercise sensitive professional judgment in all their activities.

36 The 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. Principles of the AICPA Code of Professional Conduct

37 Integrity To maintain and broaden public confidence, members should perform all professional responsibilities with the highest sense of integrity. Principles of the AICPA Code of Professional Conduct

38 Objectivity 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. Principles of the AICPA Code of Professional Conduct

39 Due 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. Principles of the AICPA Code of Professional Conduct

40 Scope 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. Principles of the AICPA Code of Professional Conduct

41 An Ethicist’s Basic Approaches to Moral Reasoning (1)The utilitarian model, which evaluations 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.

42 Creative and Critical Thinking Impact on Problem Solving Recognize Problem Identify Alternatives Evaluate Alternatives Select Solution Implement Solution Creative Thinking Critical Thinking

43 C hapter 1 The End

44