Intermediate Financial Accounting I Financial Accounting and Accounting Standards

Environment and Theoretical Structure of Financial Accounting2 Objectives of the Chapters 1. Understand the need to develop accounting standards. 2. Study the development of accounting standards from a historical perspective. 3. The GAAP and the FASB Accounting Standards Codification. 4. Study the roles of the AICPA and the SEC in developing GAAP. 5. Introduce the accounting standard setting process of the FASB.

Environment and Theoretical Structure of Financial Accounting3 Objectives of the Chapters (contd.) 6. Study the relationship between the changes in the economic environment and the development of accounting standards. 7. Understand the economic consequence of accounting standards. 8. Understand the accounting standard compliance system in the U.S. (a Public/Private partnership)

Environment and Theoretical Structure of Financial Accounting4 Objectives of the Chapters (contd.) 9. Discuss financial reporting reform and the Sarbanes and Oxley Act (t he Public Company Accounting Reform and Investor Protection Act of 2002 ) 10. Study the need for international accounting standards and the convergence of the U.S. accounting standards with the International Accounting Standards.

Environment and Theoretical Structure of Financial Accounting5 Financial Reporting: An Introduction and Historical Development 1. What is accounting? 2.How do we communicate financial information? u Tools: Four financial statements. 3. How do we prepare financial statements? u Identify, measure and record business transactions for business entities. u Journal entries, posting to ledger accounts, work sheet (including adjustments…), F/S,… 4. Why do we need accounting standards?

What is Accounting ? An information system to account for all business transactions and translate these transactions into accounting terms to be reported in financial statements for interested users. Environment and Theoretical Structure of Financial Accounting6

7 Accounting Standards n Accounting methods with substantial authoritative support to be used by business entities in preparing external reports for users.

Environment and Theoretical Structure of Financial Accounting8 Issues Related to Accounting Standards 1. Who are the authorities to set these standards (Generally Accepted Accounting Principles, GAAP)? 2. What are these standards? What is FASB Codification? 3. The roles of the AICPA and the SEC in developing GAAP. 4. The accounting standard setting process of the FASB.

Environment and Theoretical Structure of Financial Accounting9 1934Congress SECRegulation S-X ASR and FRR Staff Accounting Bulletins 1938Accounting Profession AICPA CAP ………ARBs (51) APB ………APB Opinions (31) 1973FASB …….1. Statement of Financial Accounting Standards 2. Interpretations 3. Concepts of Financial Accounting 4. Technique Bulletins/Staff P. 5. Abstracts issued by EITF YearAuthorityOfficial Release 9

Environment and Theoretical Structure of Financial Accounting10 Pronouncements of the FASB 1. Statement of Financial Accounting Standards (SFAS) 2. Interpretations 3. Abstracts of EITF (Emerging Issue Task Force) 4. Technique Bulletins/Staff Positions 5. Statements of Financial Accounting Concepts

Environment and Theoretical Structure of Financial Accounting11 GAAP (General Accepted Accounting Principles) n Accounting methods having “substantial authoritative support” and used by business entities in preparing financial statements.

Environment and Theoretical Structure of Financial Accounting12 U.S. GAAP (contd.) n Includes: 1. FASB statements ( Present) 2. FASB Interpretations ( Present) 3. APB Opinions ( ) 4. APB Interpretations ( ) 5. CAP, ARBs ( ) 6. Other Authoritative Pronouncements (i.e., ASR & FRR of the SEC, Technique Bulletins/Staff Positions of FASB, and Staff Acct. Bulletins of the SEC, Abstracts of EITF, SOP of the AICPA, etc.)

Environment and Theoretical Structure of Financial Accounting13 FASB Accounting Standards Codification (ASC) ( Source: SFAS 168) n Effective July 1, 2009, FASB Accounting Standards Codification became the single source of authoritative, nongovernmental US GAAP. n The pronouncements of the SEC are also sources of authoritative GAAP for SEC registrants.

Environment and Theoretical Structure of Financial Accounting14 FASB Accounting Standards Codification (ASC) (Contd.) n All other non-grandfathered, non-SEC accounting literature NOT included in the Codification will be non-authoritative. n The Codification does not change GAAP but only the way the existing accounting standards are organized.

Environment and Theoretical Structure of Financial Accounting15 What Are Included in the FASB Codification? (Source: The FASB Accounting Standard Codification : Notice to Constituents About the Codification) n The Codification includes: n FASB: Statements (FAS), Interpretations, (FIN)Technical Bulletins (FTB), Staff Positions(FSP) and Staff Implementation Guides (Q&A). n EITF: Abstracts and Topic D n Derivative Implementation Group Issues n APB Opinions n ARB

Environment and Theoretical Structure of Financial Accounting16 What Are Included in the FASB Codification? (Continued) n AICPA: Statements of Position(SOP), Audit and Accounting Guides (accounting content only) and Practice Bulletins (PB). n SEC: Regulation S-X, FRR, ASR, Interpretive Releases, SEC Staff Guidance in Staff Accounting Bulletins(SAB), EITF topic D and SEC Staff Observer comments.

Environment and Theoretical Structure of Financial Accounting17 What Are Not Included in the FASB Codification? ( source: The FASB Codification Project by J. Cathey) n The followings are excluded from the Codification: a)SEC content not specifically directed to financial reporting (i.e., MD&A guidance) b)Governmental accounting standards and auditing standards, tax codes c)Concepts Statements of FASB

Environment and Theoretical Structure of Financial Accounting18 FASB Codification: the Codification Research System (Source: SFAS 168) n Codification Research System (CRS). is an online database developed by the FASB to allow users to access the Codification (and therefore, authoritative GAAP) online. n CRS uses a numerical index system in which numerical numbers are used to correspond with topics, subtopics, sections and paragraphs.

Environment and Theoretical Structure of Financial Accounting19 FASB Codification: An Example (see Illustration 1-5 on p15) n Example (source: p14 of textbook) n Search GAAP for the subsequent measurement for loans and trade receivables not held for sale (Codification ): n Topic: ASC 310 (Receivable topic) n Subtopics: ASC (for Overall subtopic) n Sections: ASC (to access the Subsequent Measurement Section) n Paragraph: ASC (to assess the Loans and Trade Rece. Not Held for Sale Para.)

FASB Codification: An Example Environment and Theoretical Structure of Financial Accounting20

Environment and Theoretical Structure of Financial Accounting21 The Role of the AICPA On Standard Setting u CAPARBs u APBOpinions u Present1. Issue Papers (by AcSEC) a 2. Statements of Position 3. Practice Bulletins 4. Auditing Standards (by the Auditing Standards Board) (Replaced by PCAOB in 2002) a.The Accounting Standards Executive Committee which was established within the Accounting Standard Division of the AICPA.

Environment and Theoretical Structure of Financial Accounting22 The Accounting Standard Setting Process of the FASB (A Due Process) (source: FASB 2011 Website (See Illustration 1-3 on p11) 1. The Board identifies an accounting issue based on requests received from various sources. 2. The Chairman decides whether to add a project to the technical agenda after consulting with other members and subject to oversight by the Foundation’s Board of Trustees.

Environment and Theoretical Structure of Financial Accounting23 The Accounting Standard Setting Process of the FASB (A Due Process) 3. The Board deliberates various issues identified and analyzed by the staff at one or more public meetings. 4. The Board issues an Exposure Draft to seek input from interested parties. ( In some case, the Board may issue a Discussion Paper to obtain comments prior to issuing the Exposure Draft.)

Environment and Theoretical Structure of Financial Accounting24 The Accounting Standard Setting Process of the FASB (A Due Process) 5.The Board holds a public roundtable meeting on the Exposure Draft, if necessary. 6.The staff analyzes comment letters, public roundtable discussion, and any other information. The Board redeliberates the proposed provisions at one or more public meetings.

Environment and Theoretical Structure of Financial Accounting25 The Accounting Standard Setting Process of the FASB (A Due Process) 7.The Board issues an Accounting Standards Update to amend ASC by a simple majority vote (i.e., four of the seven board members). n Note: effective 1/2011, FASB members expanded from 5 to 7).

Environment and Theoretical Structure of Financial Accounting26 The Accounting Standard Setting Process of the FASB (A Due Process) (soruce: Kieso, et al. 14 th edition, illustration 1-3)

Environment and Theoretical Structure of Financial Accounting27 Other Issues Related to Accounting Standards 1. Changes of the economic environment and the development of accounting standards. 2. The economic consequence of accounting standards. 3. The accounting standard setting and enforcement systems in the U.S. and the interrelationship of the Securities and Exchange Commission (SEC) and the Financial Accounting Standards Board (FASB).

Environment and Theoretical Structure of Financial Accounting28 Changes of the Economic Environment and the Development of Accounting Standards. Example: u SFAS No. 13 (Accounting for Leases) u SFAS No. 33 and 89 (Financial Reporting and changing prices) u SFAS No. 52 (Foreign Currency Translation) u SFAS No. 123 (Accounting for Stock- Based Compensation) and SFAS No. 123 (R)

Environment and Theoretical Structure of Financial Accounting29 Economic Consequence of Accounting Standards Examples: u SFAS No. 106 (Employers’ accounting for post-retirement benefits other than pensions.) u SFAS No. 115 (Accounting for certain investments in debt and equity securities.) u EITF and ASU (ASC ) on revenue recognition for multiple-element arrangements.

Environment and Theoretical Structure of Financial Accounting30 The Accounting Standard Setting and Enforcement Systems n The interrelationship of the SEC and the FASB: FASB: the rule making body. SEC: the enforcing agency.

Environment and Theoretical Structure of Financial Accounting31 The Financial Reporting Reform and the Sarbanes and Oxley Act n The collapse of Enron, the dissolving of Arthur Andersen and the accounting scandals of some high-profile firms (WorldCom, Xerox, Global Crossing, etc.) severely damaged public confidence in the accounting profession and the financial reporting. n At the demand of the public, Sarbanes and Oxley Act was passed to restore the public confidence in the credibility of the financial reports.

Environment and Theoretical Structure of Financial Accounting32 The Financial Reporting Reform and the Sarbanes and Oxley Act (Cont.) n Key Provisions of the Act including: n Creating Public Company Accounting Oversight Board to: 1) establish the auditing standards, 2) oversee the auditing profession’s auditing work to protect the interest of the investors and the public. n Increasing Corporate Executive Accountability: they must personally certify both the financial statements and disclosures) n Prohibition of Non-Audit Services (i.e., bookkeeping, internal audit, appraisal, and other consulting services)

Environment and Theoretical Structure of Financial Accounting33 The Financial Reporting Reform and the Sarbanes and Oxley Act (Cont.) n Retention of work Papers for 5 years. n Audit partner’s Rotation. n Conflict of Interest. n Hiring of Auditor by the audit committee, comprising members with financial expertise,, not the management. n Evaluation of Internal Control: the management needs to document and assess the effectiveness of internal control. Auditors of the firm need to state:1)whether the management’s assessment is fair, and 2)whether the internal control of the firm is effective.

Environment and Theoretical Structure of Financial Accounting34 The Need for International Accounting Standards n Companies doing business in more than one nation found that it is hard to comply with more than one set of accounting standards established by authorities in different nations. n In response to this problem, International Accounting Standards Committee (IASC) was founded in 1973 to develop a single set of global accounting standards.

Environment and Theoretical Structure of Financial Accounting35 The History of International Accounting Standard Setting (cont.) n 41 International Accounting Standards (IAS) were issued by IASC. n IASC created International Accounting Standards Board (IASB) in April, 2001 to be in charge of prescribing the standards. n IASB endorsed 41 IAS and named its pronouncement as International Financial Reporting Standards (IFRS).

Environment and Theoretical Structure of Financial Accounting36 Convergence of the U.S. Accounting Standards and the International Accounting Standards n To increase the international comparability and the quality of US accounting standards, the FASB has been engaged in activities to increase the convergence of the accounting standards. n The FASB is working closely with the IASB toward the convergence of accounting standards.

Environment and Theoretical Structure of Financial Accounting37 Convergence of the U.S. Accounting Standards and the International Accounting Standards n The goad of convergence is to develop a single set of high-quality international standards to be used for domestic and cross-board reporting. n Both IASB and FASB acknowledged that convergence of IFRS and U.S. GAAP is a primary objective of both Boards.

Environment and Theoretical Structure of Financial Accounting38 Short-Term International Convergence (source: FASB Project Updates and Progress Report on IASB-FASB Convergence Work Issued on 4/22/2011)) n To achieve this objective and to improve the financial reporting in the US, the FASB started a short term project, conducted jointly with the IASB, to eliminate narrow differences between US GAAP and IFRS (or IAS) since October, 2002.

Environment and Theoretical Structure of Financial Accounting39 Short-Term International Convergence (contd.) n The following areas have been addressed: n 1. Share-Based Payment (SFAS No. 123 (R): Accounting for Stock-Based Compensation. (issued in 12/2004) Substantially converging with IFRS requirements. n Revision: required the option expense to be recognized in the income statement.

Environment and Theoretical Structure of Financial Accounting40 Short-Term International Convergence (contd.) n 2. Inventory Costs (SFAS No. 151: Inventory Costs (for idle capacity and spoilage) : an amendment of ARB No. 43, Chapter 4. Issued in 11/2004, converging with IFRS requirements. n Revision: The amounts of costs (I.e., idle facility expense, freight, handling costs, spoilage) are expensed.

Environment and Theoretical Structure of Financial Accounting41 Short-Term International Convergence (contd.) n 3. Asset Exchanges ( SFAS No. 153: Exchanges of Nonmonetary Assets, issued in December 2004 ): an amendment of APB Opinion No. 29. Converging with IFRS requirements. n Changes: eliminating some differences in measurement between APB 29 and that of IAS 16 and IAS 38 (i.e., difference in the treatment of nonmonetary exchange of similar productive assets.)

Environment and Theoretical Structure of Financial Accounting42 Short-Term International Convergence (contd.) n 4. Accounting Changes ( SFAS No. 154: Accounting Changes and Error Corrections, issued in May 2005): a replacement of APB No. 20 and FASB No. 3. Converging with the IFRS requirmenets. n Eliminating the current period approach in accounting for the voluntary accounting changes. n Result: improve the comparability of international financial reporting by eliminating the differences between APB 20 and IAS 8.

Environment and Theoretical Structure of Financial Accounting43 Short-Term International Convergence (contd.) n 6. Discontinued activities: n The IASB issued IFRS 5 ( Non-current Assets Held for Sale and discontinued Operations) in 2004 which substantial convergence with US GAAP on this topic. However, the definitions of discontinued Operations between two sets of standards remain divergent..

Environment and Theoretical Structure of Financial Accounting44 Short-Term International Convergence (contd.) n 7. Fair Value Option: FASB 159, the fair value option for financial assets and liabilities, issued in n 8. Research Costs: FAS 141R, Business Combination issued in 2008, amending the accounting for acquisition. n 9. Non-Controlling Interests : FAS 160 issued in n 10. Joint ventures: IFRS 11 to be issued in 2011.

Environment and Theoretical Structure of Financial Accounting45 Short-Term International Convergence (contd.) n 11. Income Tax: Reassessed as a lower priority project. n 12. Investment Properties: in process, the FASB is developing proposals to align US GAAP with IFRSs. n 13. Business Combinations: Project completed and standard issued in n 14. Consolidated Financial Statements: in process.

Environment and Theoretical Structure of Financial Accounting46 Short-Term International Convergence (contd.) n 15. Fair Value Measurement: ASU issued in May, 2011 and IFRS 13 to be issued in n 16. Post-Employment Benefits: IFRS to be issued to amend IAS 19. n 17: Financial Statement Presentation- Other Comprehensive Income: FASB issued ASU in June Amendments to IFRSs to be issued in 2011.

Environment and Theoretical Structure of Financial Accounting47 Short-Term International Convergence (contd.) n Others in progress: n Accounting for Leases (EP 8/17/2010, updated EP issued on 8/18/2011 for re- exposure) n Revenue Recognition (EP 1/24/2010, updated EP issued on 8/3/2011 for re- exposure) n For details, go to:

Environment and Theoretical Structure of Financial Accounting48 Current Compliances n Since there is no single set of high-quality accounting standards, domestic (U.S.) firms filing reports with the SEC must use U.S. GAAP. n Foreign issuers filing reports with the SEC can use U.S. GAAP, the international standards or the GAAP of its home country. n If foreign firms chose not to use U.S. GAAP, they must file reports with reconciliation to U.S. GAAP.

A Single Global Accounting Language - International financial reporting standards  In November 2008, the Securities and Exchange Commission (SEC) proposed a roadmap for the US issuers to prepare financial statements in accordance with “IFRS” for the purposes of their filings with the SEC.  This roadmap, if achieved, could lead to the required use of IFRS by U.S. issuers in 2015 or

A Single Global Accounting Language - International financial reporting standards (Contd.)  In February 2010, the SEC reaffirms its commitment to one set of accounting standard and continues to encourage the convergence of standards between the US GAAP and IFRS.  On 10/29/2010, the SEC issued its first Progress Report on its Work Plan on the possible move toward the adoption of the IFRS for the US issuers.  The SEC will make the decision of adopting IFRS for US issuers in

The SEC’s Roadmap Toward Global Accounting Standards Environment and Theoretical Structure of Financial Accounting51