Lesson 11 Understanding Accounting Principles

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Lesson 11UnderstandingAccounting Principles

• Task Team of
• FUNDAMENTAL ACCOUNTING
• Business School, Sun Yat-sen University

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Outlines

• Accounting standards a tool for trusting
• Introduction of Accounting Standards
• Accounting Standards in China
• A Brief of Accounting Theory

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Opening Story

• Enron scandal again!
• Filed 8-K to restate its financial statements in
  November 8, 2001
• Filed bankruptcy protection under Chapter 11 in
  December 3, 2001
• Mr. Berardino, then CEO of Andersen, issued an
  announcement Enron, a wakeup call
• Accounting standards is the firstto be blamed

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Opening Story

• The standards involved in Enron case
• Special purpose entity (SPE)
• FASB on SPE
• 3 independent interest
• Assume substantially the risk
• Enron and Andersen stick to 3 requirement,
  ignoring the risk assessment requirement
• Accounting Standards or standards enforcement?

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Accounting and Trust

• How could accounting help to develop trust?
• Translate all business activities into numeric so
  it could be summarized, measured and evaluated
• Managers may report and discharge their
  accountability
• Principal-agent problem
• Since all common investors are principals
• Free-rider issues are pervasive
• How to assure managers to provide financial
  report truthfully and reliably?

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Accounting and Trust

• Are financial reports reliable and objective?
• The inherent limitation of financial accounting
• Monetary measurement penny wise and pound
  foolish
• Where to put Bill Gates on Microsofts Financial
  Statements?
• Historical cost, accrual basis, periodic report
• Financial reporting are lagged, no matter good
  news or bad news
• Be aware all managers, including accountants,
  are REMMs
• Accounting comes down to the-vehicle-for-bank-robb
  ers
• All the blames to accounting for its unique
  role in Yinguangxia, Enron, WorldCom, etc.

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Accounting and Trust

• To assure the reliability of accounting
  information, many mechanism are devised and
  employed
• Periodic and timely disclosure
• Full disclosure
• Accounting standards
• Why generally accepted?
• Auditing
• Additional tool to assure the reliability of
  accounting information.

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Accounting Standardsa Trust Perspective

• REMMs push the lines as hard as possible
• Executives will abuse accounting numbers given
  that these numbers are essential in their
  performance evaluation
• Incentive to manage and manipulate earnings.

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Open discussion

• Revenue recognition criteria
• Earned process done, considerations guaranteed
• How to account for
• Sell and repurchase transactions?
• Sell and lease-back transactions?
• The criteria satisfied
• But they are financing in substance

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Accounting Standardsa Trust Perspective

• In order to solve the disputes on accounting
  choices, agreement on the set of accounting
  choices is necessary
• We define this as accounting standards
• It is also named as GAAP in US

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Introduction ofAccounting Standards

• Varied terms,
• Accounting norms
• Accounting principles
• Accounting standards
• GAAP
• International Accounting Standards,
• Financial reporting standards
• ,,,
• Focus on substance, not form

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Introduction of Accounting Standards

• Accounting standards
• Must be authoritatively supported
• Otherwise, no binding effect
• Two ways to gain authoritative support
• Authoritativeness from Governmental
  administration
• Ministry of Finance acting as standards setter
• Widely represented to gain authoritativeness
• This is the case of FASB before 2002
• PCAOB, a quasi-governmental agency, stepped in
  after 2002.

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Introduction of Accounting Standards

• Accounting standards must be effective in
  resolving disputes
• Still two ways to reduce disputes
• Focus on scientific principles to guide
• Furnish with cooking-book solutions
• This is the story of principle-based and
  rule-based.

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Introduction of Accounting Standards

• Accounting standards in China
• Accounting Law, 2000
• Regulations for Business Financial Reporting,
  State Council, 2000
• Business Accounting Standards, Ministry of
  Finance
• New standards will be expected
• Unified Accounting Systems, Ministry of Finance,
  2001
• Temporary explanations
• A whole new set of Enterprises Accounting
  Standards, Ministry of Finance, 2006

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Introduction ofAccounting Standards

• CSRC and its role in regulating public companies
  accounting practice
• Two sets of regulations
• Information disclosure on forms and contents
• Rules for information disclosure
• Actually affect public companies accounting
  practice
• The change of rules on Non-recurring gains and
  losses

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Introduction ofAccounting Standards

• Accounting standards itself is in the state of
  keep-changing
• The early stage of A/S, easy and simple
• The first batch of A/S only includes 6 items when
  approved by AIA and NYSEC in 1933
• More complicated
• 154 statements published by FASB as to May 2005

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Introduction ofAccounting Standards

• Although A/S is in the state of changing, there
  are still some stable contents
• Accounting assumptions
• Basic principles
• Accounting conventions

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Introduction ofAccounting Standards

• Accounting assumptions
• Impossibility to prove to be true
• Indispensable to accounting practice
• May be treated as prerequisites
• Business Entity
• Going-concern
• Periodic reporting
• Monetary valuation

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Introduction ofAccounting Standards

• Basic Accounting Principles
• Substance over Form
• Most important one
• Theoretically, one for all
• Back to Enron case
• Accrual Basis
• Revenue Realization
• Matching

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Introduction of Accounting Standards

• Actual cost
• Historical cost
• Fair Value
• Why does Historical Cost dominate?
• Prudence
• The definition
• Why do we need it?

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Class discussion

• Read the materials about Southern Airlines and
  Xiamen Airlines
• Which one is more prudent?
• Please find out the underlying reason

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Story about Principle-based and Rule-based

• From high quality accounting standards to
  principle-based
• Definition of Principle-based
• Are IASs principles-based?
• Definition of Rule-based
• Are US GAAP rule-based?
• Objective-based
• A right way?

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Accounting Standards Evolution in China

• After 1949, we killed all the market
• Everything is under central planning
• We planned everything, including those
  unplannable
• No corporate finance
• No decision making oriented management
  accounting
• Costing not cost controlling
• No auditing
• No accounting standards too.

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Accounting Standards Evolution in China

• Capital markets were founded in Shanghai and
  Shenzhen in early 1990s
• Public companies will be responsible for common
  investors
• Accounting standards are necessary again
• 1992, Business Enterprises Accounting Standards
  are issued
• 1997, the first operational accounting standards
  was issued

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Accounting Standards Evolution in China

• Completely revised since 2001
• The issuance of Unified Accounting System
• Abandon fair value accounting
• Readopt actual cost
• Put restrictiveness on earnings
• From earning to capital surplus
• Internationalization or localization

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Accounting Theorya deconstruction view

• Derrida and Deconstruction
• Accounting theory
• Traditional normative definition
• A Classical article for positive definition
• Watts and Zimmerman, 1979,

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Accounting TheoryA deconstruction view

• Accounting theory is regarded as nothing
  different from common goods
• It is demanded
• It is supplied
• Who does?
• Unregulated and regulated society

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Accounting TheoryA deconstruction view

• The demand for A/T in unregulated society
• Pedagogy
• Information
• Justification
• The demand for A/T in regulated society
• Accounting numbers based regulation and its
  impact on the demand for right A/T

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Accounting TheoryA deconstruction view

• The implication to A/R
• Generally accepted an expectation, not reality
• Cases from China
• Debate on internationalization of accounting
  standards
• Supplementary auditing
• High quality accounting standards

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Summary

• The unique value of accounting
• Cost-effective trusting mechanism
• Accounting numbers are the center of the interest
  disputes
• Accounting standards are necessary
• REMMs determine that A/Ss are relatively
  effective
• The demands lead the making ofaccounting theory

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Case for Open Discussion

• Please find articles and comments on Enron and
  WorldCom, answer following questions
• Which is abusing standards? Which completely
  false information?
• Check with FASB website and find out the
  standards issued raised in Enron case
• Based on the discussion of principle-based, do
  you think these new standards/regulations are
  effective enough? Why?

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The End of Lesson 11