ACCOUNTING: The Language of Business Lecture 2

Learning Objectives (LO) After studying this chapter, you should be able to Explain how accounting information assists in making decisions Describe the components of the balance sheet Analyze business transactions and relate them to changes in the balance sheet Prepare a balance sheet from transactional data Compare the features of sole proprietorships, partnerships, and corporations

Learning Objectives (LO) After studying this chapter, you should be able to Identify how the owners’ equity section in a corporate balance sheet differs from that in a sole proprietorship or partnership Explain the regulation of financial reporting including differences between U.S. GAAP an IFRS Describe auditing and how it enhances the value of financial information 9. Evaluate the role of ethics in the accounting profession 3 of 35

LO – 6 Differences in Reporting Owners’ Equity Proprietorships and Partnerships Owners’ equities = “Capital” Owners’ equities are recorded in the capital account Corporations Owners’ equities (Residual interests in the company) also called Stockholders’/Shareholders’ equity Total capital investment = Paid-in capital (e.g., $20) Common stock recorded at par/stated value Par/stated value = what is printed on the stock One share × $5 par value = $5 Paid-in capital in excess of par value One share × ($20 – $5 par value) = $15

LO – 6 Differences in Reporting Owners’ Equity Shareholders elect a board of directors to look out for their interests Board of Directors Often include outsiders such as CEOs and presidents of other corporations, academics, attorneys, and community representatives Can also include insiders – company’s CEO, CFO, etc. Majority must be independent if stock is regulated Set strategic direction of the company Senior Managers – run day to day operations

LO – 7 Regulation of Financial Reporting Federal Government Legislative (Congress) passes laws and funding for federal agencies Judicial – enforces laws Executive – Proposes, signs, administers budgets and laws (see SEC below) SEC – Has statutory authority to regulate investment management activities regulate stock market activities investigate violations of security laws control financial reports and their preparers

LO – 7 Regulation of Financial Reporting Financial Accounting Standards Board (FASB) Independent nonprofit organization Writes accounting/reporting standards for not-for-profit organizations Has delegated authority from SEC to create and amend financial accounting/reporting standards for for-profit organizations subject to control by the SEC Authority may be rescinded at any time

LO – 7 Regulation of Financial Reporting FASB (continued) Does not have investigatory or enforcement authority Published over 160 separate opinions that include Generally Accepted Accounting Principals (GAAP) Selected recent/current projects Codification (now only one set of guidance) Convergence with the IFRS

LO – 7 Regulation of Financial Reporting International Accounting Standards Board (IASB) Not a U.S. governmental agency United States is represented on the board Creates and amends financial accounting and reporting standards for European Union and many other countries Selected current projects: Convergence with U.S. GAAP

LO – 7 Regulation of Financial Reporting Sarbanes Oxley Act – 2002 Board of directors must have an audit committee composed only of “independent” directors Management must examine and certify the adequacy of internal controls used by its company Prohibits public accounting firms from providing audit clients with certain non-audit services Requires rotation every 5 years of the lead audit or coordinating partner and the reviewing partner

LO – 7 Regulation of Financial Reporting Sarbanes Oxley Act – 2002 (continued) Established the Public Company Accounting Oversight Board (PCAOB) Subordinate to the SEC Writes Generally Accepted Auditing Standards (GAAS) that external auditors must follow when conducting an audit Writes policies directed toward management regarding internal controls of the companies Investigates audit and management compliance SEC approves recommended disciplinary actions

LO – 7 Regulation of Financial Reporting American Institute of Certified Public Accountants (AICPA) National voluntary membership association of CPAs Sets strategic direction for the profession Members must abide by a code of conduct Writes/grades/updates the Uniform CPA Examination XXX Society of CPAs Each state has its own society Advocate for the profession within the state Provides multiple goods and services to members

LO – 7 Regulation of Financial Reporting State Boards of Accountancy (SBA) Sets knowledge, integrity, and ethics policies Uses the Uniform CPA Exam, written and graded by the AICPA, as part of the licensing process Licenses and disciplines CPAs Requires certain number of professional-subject courses (continuing professional education [CPE]) to be taken within a period of time to maintain license Works with other SBA on reciprocity of CPA licenses between states

LO – 8 Auditing 1929 Stock Market Crash – Senior managers Rewarded in part by content of financial statements Prepare financial statements Potential for bias SEC Act of 1934 required public companies to have their financial statements audited by independent outside auditors who are CPAs File results with the SEC Shareholders – audit report adds credibility to the financial statements they use when making decisions

LO – 8 Auditing The four largest international public accounting firms are Deloitte Touche Tohmatsu Ernst & Young KPMG International PricewaterhouseCoopers 97% of the firms listed on the NYSE are clients of these four firms National, regional and local firms also exist Offer fee-based tax, consulting, auditing services

LO – 8 Auditing Audit – examination of a company’s transactions and the resulting financial statements Standard report includes the following topics: Introduction – what was audited? Scope – how was the audit conducted? Opinion as to fairness of financial statements degree to which GAAP was followed Other topics (e.g., changes in principals, adequacy of management’s review of internal controls) (

LO – 9 Ethics Ethics – doing what is right for all stakeholders Ethics are an integral part of the accounting profession and are stressed in guidance from the following: Professional societies (AICPA, IMA, state societies) Regulatory bodies (SEC, PCAOB, SBA) Accounting firms (international, national, regional, local) Publically traded firms (set the “tone at the top”) Nevertheless – greed often trumps ethics

Miscellaneous The Governmental Accounting Standards Board (GASB) regulates disclosures for nonfederal governmental organizations (states and below, organizations, etc.) More CEOs started out in finance or accounting than any other area, i.e., Accounting provides an excellent training ground for future managers and executives