1. ACF 101-102 Introductory Financial Accounting Introductory Financial Statement Analysis
Lecture 5

2. Learning Outcome
Understand the accounting concepts and conventions present in accepted accounting principles Demonstrate knowledge and understanding of ethical issues in this area Appraise financial performance and the position of an organisation through the calculation and review of a number of basic ratios.

3. Topics Regulation of Financial Reporting Ethics
Basic accounting concepts

4. Explain the purpose of accounting systems, accounting classifications and understanding accounting conventions within the context of professional regulatory requirements.

5. 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

6. 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Authority may be rescinded at any time

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

8. 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

9. 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

10. 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

11. In 2002, the U.S. Congress passed the Sarbanes-Oxley Act, which gave the government a larger role in regulating the audit profession.

12. Sarbanes-Oxley Act regulations
Establishment of the Public Company Accounting Oversight Board with powers to regulate many aspects of public accounting and to set standards for audit procedures,
Prohibiting public accounting firms from providing to audit clients certain nonaudit services,

13. Sarbanes-Oxley Act regulations
Rotation every five years of the lead audit or coordinating partner and the reviewing partner on an audit,
Boards of directors of publicly held companies to appoint an audit committee composed only of “independent” directors,

14. Sarbanes-Oxley Act regulations
CEOs and CFOs personally sign a statement certifying the appropriateness and fairness of their companies’ financial statements, and
Increasing the criminal penalties for knowingly misreporting financial information.

15. 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

16. 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

17. Describe auditing and how it enhances the value of financial information.

18. The credibility of financial statements is the ultimate responsibility of the managers who are entrusted with the resources of the entity under their command.

19. Third-party assurance about the credibility of financial statements gave rise to the CPA profession. An auditor examines the information that managers use to prepare the financial statements and provides assurances about the credibility of those statements.

20. A certified public accountant (CPA) earns this designation by a combination of education, qualifying experience, and the passing of a two-day written national examination, administered and graded by the American Institute of Certified Public Accountants (AICPA).
ACCA
ACA
CIMA

21. An audit is an in-depth examination of transactions and financial statements made in accordance with generally accepted auditing standards developed by the AICPA.

22. The audit is conducted by an independent CPA to lend credibility to management's financial statements and is described in the auditor's opinion . An auditor’s opinion (also called an independent opinion) describes the scope and results of the audit, and companies include the opinion with the financial statements in their annual reports.

23. The American Institute of Certified Public Accountants (AICPA) is the principal professional association in the private sector that regulates the quality of the accounting profession.

24. 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

25. 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

26. 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)

27. Evaluate the role of ethics in the accounting process.
Members of the AICPA, as well as members of the Institute of Management Accountants, must abide by a code of professional conduct, which is especially concerned with integrity and independence. Professional accounting organizations have procedures for reviewing behavior alleged as not being consistent with the codes of professional conduct

28. 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

29. 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

30. Explain the regulation of financial reporting, including differences between U.S. GAAP and IFRS.

31. Generally accepted accounting principles (GAAP) applies to all broad concepts and detailed practices to be followed in preparing and distributing financial statements

32. The Financial Accounting Standards Board (FASB) is responsible for establishing GAAP in the United States. The U. S. Congress has charged the Securities and Exchange Commission (SEC) with the ultimate responsibility for authorizing GAAP for companies whose stock is held by the general investing public.

33. However, the SEC has informally delegated much rule-making power to the FASB. Congress can, however, overrule both the SEC and the FASB.

34. The International Accounting Standards Board (IASB) was established to develop, in the public interest, a single set of high quality, understandable, and enforceable global accounting standards.

35. The IASB sets International Financial Reporting Standards (IFRS)
The IASB sets International Financial Reporting Standards (IFRS). IFRS is used in more than countries around the world, including all European Union countries. The IASB has 16 members who represent a diversity of geographic and professional backgrounds.

36. BASIC CONCEPTS
(Economic) Entity - an organization that stands apart from other organizations and individuals as a separate economic unit
The first line in the statements’ headings
Personal transactions are not recorded by a business entity
Stable Monetary Unit
Currency is used to measure events
Its purchasing power is assumed to be stable (low inflation) over time

37. BASIC CONCEPTS Going concern (continuity)
Reporting entity will continue to exist indefinitely, i.e. can use historical costs to measure long-lived assets
If liquidation is in sight, assets should be revalued to their current market value
Materiality
If it makes a difference to a decision maker, information should be separately identifiable
Immaterial – combine with other information

38. BASIC CONCEPTS Cost-benefit
Apply established criteria, i.e. U.S. GAAP or IFRS
If the costs to comply with that criteria exceed the benefits of doing so, deviations are permissible
Difficult to measure benefits – judgment which can easily lead to disagreements
U.S. GAAP contains verbiage permitting deviations justified by cost-benefit considerations

39. BASIC CONCEPTS Reliability
Management prepares and is rewarded by the content of financial statements (possible bias)
Independent auditors, in theory, add quality to those statements by offering three opinions
“Fair” presentation (unqualified)
Prepared according to the relevant accounting standards
Adequacy of internal controls
Higher quality statements makes them more reliable (useful) in decision making

40. Calculate ratios to reflect: profitability, liquidity, efficiency,
gearing,
investment;

43. interpretation of results
Ratios:
Comparison of these ratios both externally (other companies, industry standards) and internally (previous periods);
interpretation of results