Generally Accepted Accounting Principles Common set of standards for U.S. accounting Not laws, but nearly treated as such Developed primarily by Financial Accounting Standards Board (FASB) Enforced by “independent” auditing firms and the Securities and Exchange Commission (SEC) Government agency tasked with ensuring fairness in financial equity markets

History of Accounting Standards AICPA first created the Committee on Accounting Procedure (CAP) - Group of practicing CPAs - Issued 51 Accounting Research Bulletins from AICPA then created more formal Accounting Principles Board (APB) - Practicing CPAs, professors, and industry reps - Issued 31 APB Opinions from

Financial Accounting Standards Board (FASB) Formed to deter Congressional standard setting Most formal type of standard setting board Full-time board members. No external ties. Increased independence

Standard Setting Process (Making GAAP) Board addresses topics in meetings Research on the topic is conducted and summarized in discussion memorandum There is a public hearing on the topic An exposure draft is written and displayed. Comments are solicited from any interested party. Board evaluates comments and then issues final standard. 5 of 7 votes required to pass.

FASB Products Standards: Specific accounting rules (GAAP) Interpretations: Further guidance on prior standards. Also considered GAAP Concepts: Fundamental objectives of financial accounting. An overriding framework on what accounting should be. Technical Bulletins: guidance on how to implement standards for particular firms or industries Emerging Issues Task Force Statements (EITF): guidance on how to handle confusing or difficult issues Current EITF issues

GAAP Authority Structure FASB Technical Bulletins AICPA Industry Audit and Accounting Guides AICPA Statements of Position Emerging Issues Task Force (EITF) Statements AICPA Practice Bulletins ARB Research Bulletins APB Opinions FASB Standards (& Interpretations) Most Authority AICPA Accounting Interpretations FASB Question and Answer Guides Industry Practices Least Authority

Securities and Exchange Commission (SEC) Governmental enforcement agency Collects all mandatory financial filings and makes them publicly available - 10K: Firm’s annual report. Must be filed within 60 days from end of fiscal year (phased-in) Coca-Cola 10K example Abercrombie & Fitch 10Q example - 10Q: Firm’s quarterly report. Must be filed within 35 days from end of fiscal quarter (phased-in)

Levels of Conceptual Framework Basic Objectives Fundamental Concepts Recognition and Measurement Concepts

Basic Objectives of Financial Reporting To provide information useful to investment and credit decisions To provide information helpful in assessing the amounts, timing, and uncertainty of future cash flows To provide information about economic resources, the claims to these resources, and changes in them

Primary Qualitative Characteristics Relevance: Capable of making an impact in a decision. Reliability: Verifiable, free of bias or error. Secondary Qualitative Characteristics Comparability: Measured and reported similarly across firms so that comparisons can be made across firms. Consistency: Applying the same accounting method through time so that comparisons can be made over time within the same firm.

Basic Assumptions Underlying Accounting Economic Entity: economic activity can be identified to a unit (firm). Going Concern: the business enterprise will have an indefinite life Monetary Unit: there is a common monetary unit upon which to value activity Periodicity: economic activities can be divided into artificial time periods (quarters, years, etc.)

Basic Principles of Accounting Historical Cost: assets and liabilities recorded at historical cost (for reliability) Revenue Recognition: revenue should be recognized when realized and earned (as opposed to when cash or goods actually exchange) Matching: revenues should be matched to expenses that help generate them Full disclosure: firms should provide all information that is materially important to statement users

Constraints on Accounting Cost-benefit analysis: benefits from collecting and reporting information should outweigh the costs Materiality: only need to be concerned with economic events that are significant enough to matter Conservatism: report so that you are least likely to overstate assets and income

Who Uses Financial Statements? Investors: Mutual fund companies, larger companies, individual investors Creditors: Banks have accounting covenants that can trigger loan default Firms, themselves: Most high-level managers are compensated based on some mix of stock and accounting performance