CH.1 FINANCIAL ACCOUNTING AND ACCOUNTING STANDARDS
I. ACCOUNTING - is an information system that identifies, measures, and communicates financial information about economic entities to interested persons.
II.FINANCIAL ACCOUNTING - is the process of preparation of a set of general-purpose financial statements on enterprises as a whole for use by parties both internal and external to the enterprise, such as investors, creditors, managers, unions and government agencies.
Role of Accounting in Society Corporations ShareholdersCreditors Need capital Need information Company’s private accountants prepare financial statements IndependentCPAs Make economic decisions based on financial statements provided by companies Make economic decisions based on financial statements provided by companies Private accountants Public accountants Accounting related employment GAAP
III.GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAP) - those principles that have "substantial authoritative support" (meaning established by an authoritative rule making body
IV.HISTORY OF ACCOUNTING STANDARDS SETTING PRIOR TO 1929 (STOCK MKT CRASH) - No GAAP - No auditing requirement
IV.HISTORY OF ACCOUNTING STANDARDS SETTING IN 1934 Securities and Exchange Commission (SEC) was created to administer the securities laws. - SEC has the legal authority to prescribe accounting standards for companies that fall within its jurisdiction (about 12,000 public companies). - SEC has generally delegate the accounting standards setting to the private sector.
IV.HISTORY OF ACCOUNTING STANDARDS SETTING 1939 - 1959 Committee on Accounting Procedure (CAP) - Appointed by AICPA - Issued 51 Accounting Research Bulletins
IV.HISTORY OF ACCOUNTING STANDARDS SETTING 1959 - 1973 Accounting Principles Board (APB) - Created by the AICPA - Issued 31 APB Opinions
IV.HISTORY OF ACCOUNTING STANDARDS SETTING 1973 - present Financial Accounting Standards Board (FASB) - Appointed by Financial Accounting Foundation - The most significant current source of GAAP - The FASB issues: - Standards and interpretations (over 121&40) - Technical bulletins (implementation guides) - Emerging Issues Task Force (EITF) statement - Financial Accounting Concepts
What is the conceptual framework? The conceptual framework is, like a constitution, a coherent set of objectives and fundamentals that can lead to consistent standards and that prescribes the nature, function, and limits of financial accounting and financial statements.
I.Need for a Conceptual Framework 1.Coherence in rules and standards. 2.Quick solutions to new and emerging practical problems by reference to an existing framework of basic theory.
First Level: Objectives. To provide information that is useful to present and potential investors and creditors in making rational investment, credit, and similar decisions.
Second Level: Qualitative Characteristics and Elements. For information to be useful, it must be: (1)Relevance. Accounting information is relevant if it is capable of making a difference in a decision. Relevant information has (a)Predictive value. (b)Feedback value. (c)Timeliness. (2)Reliability. Accounting information is reliable to the extent that users can depend on it to represent the economic conditions or events that it purports to represent. Reliable information has (a)Verifiability. (b)Representational faithfulness. (c)Neutrality. In addition, the information must also be comparable and consistent.
Third Level: Recognition and Measurement Concepts Assumptions Principles Constraints
Third Level: Recognition and Measurement Concepts 1.Assumptions. a.Economic entity assumption—economic activity can be identified with a particular unit of accountability. b.Going concern assumption—business enterprises will have a long enough life to justify the use of accruals and deferrals. c.Monetary unit assumption—the monetary unit (i.e., the dollar) is the most effective means of expressing to interested parties changes in capital and exchanges of goods and services. A second assumption is that the monetary unit remains reasonably stable. Note that during the inflationary period of the 1970s this assumption was criticized by many accountants. d.Periodicity assumption—activities of an enterprise can be divided into artificial time periods.
Third Level: Recognition and Measurement Concepts 2.Principles. a.Historical cost principle—acquisition cost is the most objective and verifiable basis to account for assets and liabilities. Definite and objective, not subject to interpretation. b.Revenue recognition principle—revenue is recognized when (1) it’s earned and (2) It’s realized or realizable. c.Matching principle—efforts (expenses) should be matched with accomplishments (revenues) if feasible. (a)When direct association exists, expense costs against revenues in the period when the revenue is recognized. (b)When association exists but is difficult to identify, allocate costs rationally and systematically to expense in the periods benefited. (c)When little if any association exists, expense immediately. d.Full disclosure principle—revealing in financial statements any facts of sufficient importance to influence the judgment and decisions of an informed reader. Companies use of notes and supplementary information in financial reporting.
Third Level: Recognition and Measurement Concepts 3.Constraints modifying basic theory: a.Cost-benefit—the benefit to be derived from having accounting information should exceed the cost of providing it. Frequently it is easier to assess the costs than it is to determine the benefits of providing a particular item of information. b.Materiality—if the amount is significant when compared with other items, sound and acceptable standards should be followed. (1)The determination of materiality requires considerable judgment, a potential for abuse exists. (2)Immaterial items are recorded but need not be separately disclosed. c.Industry practice—peculiar nature of industry or business may result in variation. d.Conservatism—when in doubt choose the solution that will be least likely to overstate assets and income.