The Environment of Financial Reporting C hapter 1 An electronic presentation by Norman Sunderman Angelo State University An electronic presentation by Norman Sunderman Angelo State University COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Intermediate Accounting 10th edition Nikolai Bazley Jones

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3 1. Understand capital markets and decision making. 2. Know what is included in financial reporting. 3. Explain generally accepted accounting principles (GAAP) and the sources of GAAP. 4. Identify the types of pronouncements issued by the FASB. Objectives

4 5. Understand how the Financial Accounting Standards Board (FASB) operates. 6. Describe the relationship between the Securities and Exchange Commission (SEC) and the FASB. 7. Use ethical models for decision making about ethical dilemmas. 8. Understand creative and critical thinking. Objectives

5 More Accountants Needed New accounting rules pose challenges for financial accounting and projections point to increased hiring of accounting graduates.

6 Estimated Hiring Increase Accounting firms of all sizes plan to increase future hiring.

7 Companies need large amounts of capital for operations

8 Companies may obtain capital by issuing capital stock... Stock Exchange

9 Bank …or by borrowing from lenders

10 Corporations Financial InstitutionsInvestors Borrow money Sell stocks and bonds Primary Market (e.g., individuals, banks) Secondary Market (e.g., New York Stock Exchange) Buy and sell stocks and bonds Capital Markets Buy and sell stocks and bonds Investors

11 Accumu- late Accounting Information Communi- cate External User Internal User Externa l Decisio n Making Company’s Economic Activities Impact Accounting Information Economic Activities and Decision Making Internal Decisio n Making

12 1.Buy. A potential investor decides to purchase a particular security on the basis of communicated accounting information. 2.Hold. An actual investor decides to retain a particular security on the basis of communicated accounting information. 3.Sell. An actual investor decides to dispose of a particular security on the basis of communicated accounting information. External and Internal Users

13 Sources of Authority Internal needs Managerial Accounting Financial Accounting GAAP Comparison of Financial and Managerial Accounting

14 Time Frame of Reported Information Present and future Managerial Accounting Primarily historical Financial Accounting Comparison of Financial and Managerial Accounting

15 Scope Total company & Segment reporting Financial Accounting Individual departments, divisions, and total company Managerial Accounting Comparison of Financial and Managerial Accounting

16 Type of Information Primarily quantitative Sales$275,240 Cost180,120 Gross mar.95,120 Expenses 80,120 Net inc.$15,000 Financial Accounting Qualitative as well as quantitative Materials usage is unfavorable by $8,400. Managerial Accounting Comparison of Financial and Managerial Accounting

17 Statement Format Prescribed by GAAP; oriented toward investment and credit decisions Financial Accounting Determined by company; focused upon specific decisions being made Managerial Accounting Comparison of Financial and Managerial Accounting

18 Decision Focus External Financial Accounting Internal Managerial Accounting Comparison of Financial and Managerial Accounting

19 The company’s accountants prepare both the financial and the managerial accounting reports… …and the information comes from the same information system.

20 Financial reporting is the process of communicating financial accounting information about a company to external users. Financial Reporting

21 1. The balance sheet (or statement of financial position) which summarizes a company’s financial position at a given date. 2. The income statement which summarizes the results of a company’s income producing activities for a period of time. 3. The statement of cash flows which summarizes a company’s cash inflows and outflows for a period of time. Companies present at least three major financial statements: Financial Reporting

22 A statement of changes in stockholders’ equity also is included by many companies. Financial Reporting

23 This statement summarizes the changes in each item of stockholders’ equity for a period. Financial Reporting

24 GAAP are the guidelines, procedures, and practices that a company is required to use in recording and reporting the accounting information in its audited financial statements. They are like laws and are the rules that must be followed in financial reporting. Generally Accepted Accounting Principles (GAAP)

25 A.FASB Statements of Financial Accounting Standards and Interpretations, FASB Staff Positions, FASB Statement 133 Implementation Issues, APB Opinions, and CAP (AICPA) Accounting Research Bulletins, (as well as SEC releases such as regulation S- X, Financial Reporting releases, and Staff Accounting Bulletins for companies that file with the SEC) ContinuedContinued Hierarchy of Sources of GAAP CategoriesAuthoritative Sources

26 B.FASB Technical Bulletins, and, if cleared by the FASB, AICPA Industry Audit and Accounting Guides, and AICPA Statements of Position C.FASB Emerging Issues Task Force Consensus Positions and if cleared by the FASB, AICPA Practice Bulletins ContinuedContinued Hierarchy of Sources of GAAP CategoriesAuthoritative Sources

27 Hierarchy of Sources of GAAP D.FASB Q’s and A’s (Implementation Guides), AICPA Accounting Interpretations, and practices that are widely recognized and prevalent either generally or in the industry (e.g., AICPA Accounting Trends and Techniques) CategoriesAuthoritative Sources There are electronic databases such as the FASB Financial Accounting Research System (FARS) that include most accounting standards

CAP formed CAP issued 51 ARBs 1959 APB formed APB issued 31 Opinions 1973 FASB formed Present FASB issued 154 Statements of Standards as of 10/05 History of GAAP in Private Sector

29 Committee on Accounting Procedure (CAP) In 1938, the AICPA formed the Committee on Accounting Procedure. This group issued pronouncements known as Accounting Research Bulletins (ARB), but the CAP did not have authority to enforce its pronouncements and application was optional. The CAP was criticized because its members were all CPAs and application was optional, so the AICPA formed the Accounting Principles Board in 1959 to replace the Committee on Accounting Procedure.

30 1.To alleviate criticism about the process of formulating accounting principles, which included wider representation. 2.To create a policy-making body whose rules would be binding on companies rather than optional. The APB was comprised 17 to 21 members, selected primarily from the accounting profession. Reasons for Forming APB

31 1. Independence. The members of the APB were part-time volunteers whose major responsibilities were to the business, governmental, or academic organization employing them. 2. Representation. The public accounting firms and the AICPA were too closely associated with the development of accounting standards. 3. Response time. Emerging problems were not solved quickly enough by the part-time members of the APB. Criticisms of the APB

32 Financial Accounting Standards Advisory Council (approximately 30 members) Financial Accounting Standards Board (7 members) Appoint, fund, and oversee Advise Financial Accounting Foundation (16-member board of trustees) ContinuedContinued Structure of FASB

33 Task Forces of the Standards Board (including Emerging Issues Task Force) Appoint Consult Support Administrative Staff Research and Technical Staff Consult Structure of the FASB Financial Accounting Standards Board (7 members) Financial Accounting Standards Board (7 members)

34  Statements of Financial Accounting Standards  Interpretations  Technical Bulletins  Statements of Financial Accounting Concepts  Other Pronouncements Types of Pronouncements Issued by the FASB

35 Identify Topic Appoint Task Force Conduct Research Issue Discussion Memorandum or Invitation to Comment Issue Exposure Draft ContinuedContinued Deliberate on Findings Hold Public Hearings FASB Operating Procedures

36 Modify Exposure Drafts Vote (simple majority) Issue Exposure Draft Hold Public Hearings From previous page Issue Statement FASB Operating Procedures

37 Other Organizations Impacting GAAP  Securities and Exchange Commission (SEC)  American Institute of Certified Public Accountants (AICPA)  FASB Emerging Issues Task Force (EITF)  Cost Accounting Standards Board (CASB)  Internal Revenue Service (IRS)  American Accounting Association (AAA) ContinuedContinued

38  International Accounting Standards Board (IASB)  Governmental Accounting Standards Board (GASB)  Financial Executives International (FEI)  Institution of Management Accountants (IMA)  Public Company Accounting Oversight Board  CFA Institute (Chartered Financial Analyst) Other Organizations Impacting GAAP

39 FASB SEC Participants in the Development of GAAP AICPA EITF CASB GASB IMA IRSIASB AAACFAI FEI PCAOB

40 Responsibilities In carrying out their responsibilities as professionals, members should exercise sensitive professional judgment in all their activities. Principles of the AICPA Code of Professional Conduct

41 The Public Interest Members should accept the obligation to act in a way that will serve the public interest, honor the public trust, and demonstrate commitment to professionalism. Principles of the AICPA Code of Professional Conduct

42 Integrity To maintain and broaden public confidence, members should perform all professional responsibilities with the highest sense of integrity. Principles of the AICPA Code of Professional Conduct

43 Objectivity and Independence A member should maintain objectivity and be free from conflicts of interest in discharging professional responsibilities. A member in public practice should be independent in fact and appearance. Principles of the AICPA Code of Professional Conduct

44 Due Care A member should observe the profession’s technical and ethical standards, strive continually to improve competence and the quality of services, and discharge the professional responsibility to the best of the member’s ability. Principles of the AICPA Code of Professional Conduct

45 Scope and Nature of Service A member in public practice should observe the Principles of the CPC in determining the scope and nature of services to be provided. Principles of the AICPA Code of Professional Conduct

46 1. The utilitarian model, which evaluations actions based on the greatest good for the greatest number. 2. The rights model, which embraces actions that protect individual moral rights. 3. The justice model, which emphasizes a fair distribution of benefits and burdens. An Ethicist’s Basic Approaches to Moral Reasoning

47 Recognize Problem Identify Alternatives Evaluate Alternatives Select Solution Implement Solution Creative Thinking Critical Thinking Creative and Critical Thinking Impact on Problem solving

48 C hapter 1 Task Force Image Gallery clip art included in this electronic presentation is used with the permission of NVTech Inc.