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Chapter 1: Accounting: Concepts, Standards and Practice

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Title: 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
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