Financial Accounting and its Economic Context Presentations for Chapter 1 by Glenn Owen

Key Points The economic role of financial accounting statements The standard audit report, management letter, and footnotes to the financial statements. The four financial statements and the kind of financial information each provides. The two forms of investment, debt and equity, and how the information of the financial statements relates to them. Why ethics is important in the accounting process. The Securities Exchange Commission, the Financial Accounting Standards Board, and the development of generally accepted accounting principles. The current status of international accounting practices and standards.

The Financial Accounting Process Managers prepareUsers assess Investment and credit decisions are made Decisions have an effect

Basic Relationships in the Financial Reporting Process Financial Information and Fees Capital Providers Companies (Managers) Auditor Legal Liability Interest, Principle, & Dividends Debt and Equity Investments Audited Financial Information Professional Reputation and Ethics

Board of Directors Sets company policy Declares dividends Sets management compensation Hires/fires management Appoints audit committee Board of Directors Sets company policy Declares dividends Sets management compensation Hires/fires management Appoints audit committee Stockholders Elect board of directors Stockholders Elect board of directors Management Manages company Management Manages company Audit fee Auditor The Role of the Board of Directors and Audit Committee Audit Committee Helps to choose auditor and monitors management and auditor Audit Committee Helps to choose auditor and monitors management and auditor

Communicating with Users Standard Audit Report Management Letter Financial Statements Footnotes

Standard Audit Report Identifies management’s responsibility for financial statements, that the auditors performed an audit, and they are responsible for the audit opinion Indicates that the auditor applied generally accepted auditing standards States that financial information is fairly presented in accordance with generally accepted accounting principles

Management Letter Indicates that management – Is responsible for preparation and integrity of statements – Has prepared statements in accordance with GAAP – Has used their best estimates and judgment States that the company maintains a system of internal controls

Financial Statements Balance Sheet – Lists assets, liabilities, and equity at a given point in time Income Statement – Contains revenues earned and expenses incurred over a period of time Statement of Retained Earnings – Reconciles retained earnings amounts from one period to the next Statement of Cash Flow – Reconciles cash amounts from one period to the next

Footnotes Provide additional information about the dollar amounts Indicate accounting methods used Identify assumptions and estimates made by management

The Accounting Policymaking Process Generally Accepted Accounting Principles Actual Accounting Practices Economic Consequences Perceived economic consequences Policymakers SEC FASB Policymakers SEC FASB Congress, White House, government agencies Public hearings, letters Public Input

The Four Kinds of Accounting Economic Entity ManagersSystem Financial Information RecipientsDecisions Financial Accounting Not-For-Profit Accounting Managerial Accounting Tax Accounting

The Four Kinds of Accounting Economic Entity ManagersSystem Financial Information RecipientsDecisions Financial Accounting Profit-making companies Finance or accounting department GAAPIncome statement Balance sheet Statement of retained earnings Statement of cash flows Other disclosures Auditor report External Investors Creditors Suppliers Employees Managers Government General public Equity and debt investments Contract negotiations Regulation Dividend payments

The Four Kinds of Accounting Economic Entity ManagersSystem Financial Information RecipientsDecisions Not-For-Profit Accounting Nonprofit entities Finance or accounting department Fund accounting principles Balance sheet Funds flow statements External Creditors Government General public Debt investments Budget allocations

The Four Kinds of Accounting Economic Entity ManagersSystem Financial Information RecipientsDecisions Managerial Accounting All entitiesInternal accounting department Company information system Management reports Production costs Performance, evaluation, etc. Internal Managers Operating decisions

The Four Kinds of Accounting Economic Entity ManagersSystem Financial Information RecipientsDecisions Tax Accounting All entitiesFinance or accounting department Internal Revenue Code Official tax forms: 1040 for individuals 1120 for corporations External Internal Revenue Service Collection of government revenues